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What is a Directors Loan Account

We are currently in the middle of the P11d (benefits and expense) season and whilst many of you are aware that some benefits paid to employees carry a tax charge and must therefore be reported, an area that is often overlooked is that of Directors Loan Account (DLA).

If you are not sure whether you need to complete a P11d please have a read of our latest p11d blog.

In this short blog we are exploring what is a DLA and what are the tax consequences.

How do Directors take money out of their Company?

As a director of your own Company, you are still classified as an employee when it comes to tax.  Directors are treated just like any other employee and are subject to Pay As You Earn (PAYE) rules.

However, quite often a director is also a shareholder and so it is possible to structure your income to give you a tax advantage.  The structure generally follows a combination of salary and dividends.

For example, it is very common to see directors draw a lower salary of up to the secondary earnings limit (£8,840 in 2021/2022) and top it up with dividends.  This way you do not pay any PAYE tax or National Insurance Contributions (NIC) on the salary and pay some tax on dividends, which starts at an attractive rate of 7.5%.  Starting rate on a salary after all the personal tax-free allowance is used up is 20%. Everyone is entitled to a personal tax-free allowance each tax year which is currently set at £12,570.

Why pay a salary at all to a director?

A company can choose not to pay any salary to the director but there are two main advantages of paying some salary to a director. 

  • So long as the salary is above £6,240 per annum, it will count as a qualifying year for your future state pension. 
  • A payment of salary is a deductible expense for the Company attracting tax relief at 19% against corporation tax.  A dividend payment is not a tax-deductible expense.

A non-payment of salary can be considered if the director/shareholder has other sources of income, but you should always take advice before you decide because each taxpayer’s personal tax affairs are different.

What is a Directors Loan Account (DLA)

A loan to a director will arise when money is taken out of the company but is neither salary nor dividend.  It can be a useful tool to release funds to the director/shareholder during the year before deciding on dividends. 

When is the Directors Loan Account (DLA) used?

A DLA is where the money from a director and money paid to a director are recorded.  Any withdrawals from the Company bank account which are not salary, dividend or repaid expenses should be recorded here.

Depending on when these loans are taken out, it is possible to borrow up to £10,000 without being liable for tax on the amount borrowed. 

In practice most directors draw a monthly amount from the Company which would be recorded on the loan account and generally at the end of the company year end dividends are voted depending on the profits and reserves.

What tax do I need to pay on an overdrawn loan account?

If the DLA account has a balance of more than £10,000 at any time during the year, the company must report this as a benefit on the form P11d (benefits and expenses).  These need to be submitted by 6th July each year.  Class 1A national insurance at 13.8% on the benefit must be paid over too.

The benefit is worked out by applying the official rate of interest published by HMRC which is currently 2%.  Of course, to avoid the benefit the director could pay the interest element to the Company.  Any benefits on the P11d also need to be included in the self-assessment tax return and HMRC will amend the PAYE tax code.

The Company will also incur a tax based charge, referred to as s455 tax, if the loan remains outstanding nine months after the company’s year-end.  The charge is calculated as 32.5% of the outstanding balance and is reported and as part of the company tax return. The charge is repaid by HMRC as and when the director repays the loan.

Repayment of the loan and then reborrowing within 30 days are part of the anti-avoidance rules.  If within 30 days either side of making a repayment of £5,000 or more a director re-borrows money from the company, s455 tax is charged on the lower of the amount repaid and the funds borrowed – unless the repayment is out of salary or dividend.

Director’s/shareholder loans are a complex area, and you should seek professional advice where possible. Good accounting and bookkeeping practices are important when dealing with director’s loans.  We would always recommend that you use cloud accounting software which automatically reads your bank statements, so the review and balance of the DLA is always correct and readily available.

Finally…. If you provided equipment to staff during lockdown

If you have supplied your employees (including directors) with office equipment to allow them to work from home, without a transfer of ownership, there is no tax charge when they return the equipment back to you.

If you transfer the ownership of the equipment to the employee at any stage of their employment, a benefit charge generally arises on the market value of the equipment at the time of the transfer less any amount made good by the employee.

If your employee has agreed to purchase their own home office equipment for use whilst working at home as a result of coronavirus and you reimburse the exact expense, unless you have specified to your employee that they must transfer ownership to you, the ownership of the equipment rests with your employee.

There is no benefit charge on the reimbursement. There is also no benefit charge if you allow your employee to keep the equipment as it is something that they already own.

If you are looking for advice and support to complete the figures for P11d and submit forms to HMRC please do get in touch urgently as the deadline of 6th July is looming.