The Director Loan Account (DLA)

Staying on top of your director loan account can have huge benefits for a Company’s cash flow.

It’s a particularly important thing for Company Directors to understand, especially those that work with more modest levels of liquidity in their business.

It’s a bit of a fiddly one which I’ve tried to make as comprehensive as possible, but lets take a look at what the Director Loan Account is and the tax implications of mismanaging it’s balance.

 What is a Director Loan Account

The Director loan account (DLA) is a record of how much money a director owes their company or is owed to them by their company. For small business owners, transactions with family, friends and other associates will also count towards the DLA.

It is not an actual bank account. It’s a virtual account which exists in a company’s books to track the transactions between a company and it’s director(s).

A company owes their Director(s) money

Company’s that owe it’s directors money, do so usually because the director has injected some capital into the business and/or has incurred some personal expenses on behalf of the business. This is perfectly normal, and provided adequate funds are available, the loan can be repaid at any point without any tax consequence.

A Director can charge it’s company interest, however this would have to be declared as income on their personal tax return, often negating any tax saving in the company.

A Director owes their Company money (Overdrawn DLA)

Company loans to their directors can be made consciously, whereby the director draws down a fixed amount for personal needs, then repays the loan to the company over a number of instalments. Interest is added to the loan at a market rate.

Problems arise however when directors borrow from their companies, often unwittingly, then are unaware of the tax and accountancy rules that are in place. It can happen unintentionally simply by drawing more money from the company, than it has to distribute.

A simple example of how an Overdrawn DLA can arise

6 months into it’s financial year, a company has made £10,000 of profit which sits happily in it’s bank account. A Director looks at the bank account and thinks great, I have £10,000 available, and goes ahead and withdraws the funds.

But, as we know, tax is one of only two certainties in life. £1,900 (19%) of this £10,000 is payable to HMRC in the form of corporation tax.

Therefore, the director has drawn £1,900 from the company, which is not available for distribution. This £1,900 is shown as a Director Loan which must be repaid.

To build on this example further, this profit may also contain purchases that have been ‘accrued for’ and have not yet been paid, skewing the view of liquidity still further.

General principles of Interpreting your Accounts

This is the danger of using cash alone as a barometer of how healthy and wealthy the company is. Because it doesn’t take into account how much the company owes at any given time in the form of tax and other creditors.

Directors understandably are very interested their Company’s cash turnover and expenditure.

But Directors must also have an appreciation of their Company’s ‘Balance Sheet’, a statement showing how much the company owns in the form of assets (Cash, Stock etc), compared with how much it owes (liabilities such as tax bills, loans, unpaid suppliers etc).

It is the job of the Board to manage it’s ‘working capital’ in such a way that it’s short term assets consistently exceed it’s short term liabilities.

Corporation Tax implications of an overdrawn Director Loan Account

If an overdrawn Director loan is repaid within 9 months of the end of the Company’s accounting year in which the money was lent, additional disclosures are required in the Corporation Tax return which may alert HMRC. But at this stage no additional corporation tax will be due.

If a Director loan remains outstanding 9 months after the end of the Company’s accounting year, a corporation tax charge (section 455) arises equal to 33.75% of the balance of the loan.

This can cause problems with company cash flow, as this is a sizeable additional liability often unbudgeted for. The section 455 tax charge is recoverable from HMRC once the loan has been repaid however this can be a lengthy process.

Personal Tax implications of an overdrawn Director Loan Account

If a Director owes their company more than £10,000 at any point, this loan must be declared by the Director as income (known as a benefit in kind or BIK) on their personal tax return.

Interest should always be applied to a an overdrawn director loan account irrespective of the balance. This is because loans obtained from the open market are rarely (or never) interest-free. If no interest is applied, or interest is applied below the market rate, then the loan should also be declared as a benefit in kind.

National Insurance is also payable on Benefits in Kind.

Bed and Breakfasting

Directors are tempted sometimes to repay their loan at the end of their accounting year, only to borrow it again the day after. This is to conceal the loan from their Company Accounts and therefore evade tax. This is an example of Bed and Breakfasting which is not allowed and will not protect the Director from tax.

I hope that has provided a little insight into how the DLA works.

As usual if you have any questions or concerns, do get in contact.