Director’s loan account
Written by Ray Coman
As the name suggests, a director’s loan account is an amount that is owed to the company, or owed by the company to a director.
If a company is making a loss, say during its development phase, the director may need to keep it going with personal funds. This capital contribution is a creditor of the company, an amount owed by the company its director. This situation is not likely to pose any tax implication. Once the company is profitable the loan is repaid and this is not treated as income of the director.
There are tax ramifications for a director borrowing money from his or her company if it is a close company. A close company is one which is under the control of five or fewer participators, or is under the control of directors. In this sense, a participator is a shareholder or director in a close company.
Where a company makes a loan to a participator, it is required to pay a charge equal to a percentage of the loan value. Until 5 April 2016 the charge was equal to 25% the value of the loan. However, the value will be increasing to 32.5% from 2016/17. The charge is detailed in section 455 of the Corporation Tax Act 2010.
Contractors using their own company will be participators. A company can only pay dividends out of profits. If the shareholder has withdrawn more from the company than can be treated as dividend, the surplus will be treated as a loan. Since company profits are stated after corporation tax, it is often a risk for a shareholder to leave lower company assets at the year-end than the corporation tax and other liabilities.
To illustrate with a simple example, let us say that a company is in its first year of business, so there are no profits to bring forward. This example company has no equipment, and no amounts owed to it or owed by it at the year end.
The amount owed to HMRC for corporation tax shown on the accounts as a year-end liability. If the company has an amount in the company bank account which is the same as, or greater than corporation tax, then there is no overdrawn director’s loan. Amounts taken out of the company bank account can be treated as dividend.
However, a dividend can only be paid out of after tax profits. The amount by which the amount in the company bank account is lower than corporation tax liability cannot be a dividend. The amount by which the bank balance is lower than corporation tax is effectively an amount that the director has borrowed. The shortfall cannot be treated as a dividend.
In the scenario above, the company’s only assets is its bank funds. However, in practice companies will have other assets. For instance, if a director brings computer equipment, office furniture or any other equipment into the business when it starts, these ‘fixed assets’ will be acquired by the company from its director. In this case the value of the assets when brought into the company are a capital contribution. If the company is facing a shortage of funds at the year end, the assets can effectively be used to reduce the amount of the overdrawn loan.
Similarly, if the director settles certain out of pocket expenses these would also reduce the director’s loan. It is best practice to settle company expenses from the company bank account. However this might not practical, for instance where existing telephone and other contracts are already in the owner’s name. Many contractors will use their home occasionally as an office. Costs not paid from the company bank account can be deducted from profits chargeable to corporation tax, provided the costs are for a business purpose. Business expenses paid from the director’s personal bank account will reduce any overdrawn director’s loan account.
Amounts owed to the business at the year end from its clients are referred to as trade debtors. A trade debtor will reduce the director’s loan account. The director is effectively borrowing from money owed to the business, rather than from his or her own company.
In a similar vein, other assets, such as goodwill and amounts owned from other sources are also assets of the company which could be used to reduce or eliminate the director’s loan account.
To summarise, if a company is profitable and the liabilities (including amounts owed for corporation tax) are greater than assets, there is likely to be an overdrawn director’s loan. A thorough review of year end assets could identify opportunities for reduction or irradiation of director’s loan.
Fortunately, the section 455 charge will be repaid by HMRC to the company in a future tax year to the extent that the director’s loan account is reduced. If the director’s loan account is reduced to nil, any section 455 charge will be repaid in full.
To the extent that a close company waives a loan to a participator, the participator is treated as receiving a dividend equal to the amount waived.
While it is possible for a section 455 charge to be repaid, there is a cash flow drawback to paying the loan in the first place. This is because the charge cannot be repaid until nine months and one day from the end of the accounting period in which the loan is repaid. Furthermore, the administration of the s.455 refund brings about a compliance cost.