What do you do when you have an overdrawn director loan account?
Why do directors loan accounts exist?
Let us imagine that a property investor sets up a limited company to buy residential properties. They may have a share capital of £100 (100 X £1 shares) and loans the company £25,000 for the deposit of a property. This money can be repaid back to the director whenever they want and it will be tax-free. This is rather commons sense given that the company owes the directors money.
However, lets imagine that the property is revalued and an additional £50,000 is released by the mortgage provider into the company bank account. The directors decide to take the money out of the bank account for personal reasons. The original loan owed to them was £25,000 and this is repaid. However, now the directors owe the company the excess £25,000 taken in the withdrawal.
Directors loan accounts outstanding at the year end and not repaid within 9 months
Where the company is lending you as a director money this can be very expensive. We strongly advise that you have no money outstanding to your limited company at the year end. If you have any outstanding directors loan accounts then make sure it is paid back within nine months of the year end.
If there is any loan outstanding at the year end but repaid in full within 9 months there is NO tax to pay on the loan. However, if there is an outstanding amount of money owed by the directors to the company then 32.5% tax will be applied.
It does not matter how much money you owe the company. The 32.5% tax charge applies on all monies outstanding,
Directors loan account greater than £10,000
Any loans at any time which total more than £10,000 will need to be recorded on your self assessment as a benefit in kind.
The cost of the benefit in kind is calculated at HMRC official interest rate (circa 3% to 5%) of the total value of the loan as an annual charge. This interest charge is added to your salary from your limited company which could result in income tax for you. National insurance at the rate of 13.8% will also be applied to your for your limited company.
This is 32.5% tax charged is refundable once the loan is paid back however this is an additional corporation tax charge to your business in the meantime.
How can you avoid an overdrawn directors loan account?
In the above example, we saw that the directors were initially owed £25,000 by the company for the property deposit. However, the property was refinanced and the directors took £50,000 lump sum for personal reasons. This means that the directors owe the company the remaining £25,000.
This may be repaid in a number of ways:
Taking a wage and salary at the year-end, which will be subject to the usual income tax and national insurance contributions for both the employee and employer.
Taking dividends out of the company. Please remember that £2,000 dividends may be taken tax-free by each shareholder. Please also note that you can only take dividends out of a company provided that it made sufficient profits.
Write off the loan. If you write off the loan at the year end the written off value would be a benefit in kind. This would be subject to income tax for the director on their self assessment. The company would also pay 13.8% on the loan value written off
This guide was written specifically for Smart Accounting clients. Some of the information contained in this guide might not be applicable if you do not have a business managed by Smart Accounting. By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details are correct at time of writing.