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Creditors Voluntary Liquidation

 / Director's Loan Accounts Explained

Director's loan accounts explained

A director’s loan account, or a DLA, is a record of transactions between the
company and its directors. It is important to remember that whilst acting as a sole
trader or partnership, the business’ funds are technically also your funds, where in
a limited company, it is a separate legal entity so any funds you draw from the
company, take as cash or personal spending will initially be allocated to a
directors loan account. Likewise any funds you introduce will create a credit on
the directors loan account. In this article we cover the functionality and
complexities of directors loan accounts.

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Director’s loan accounts explained

Often, as director, you will put money into the company when it is set up.  This is how a directors loan account is created. On an on-going basis, you may then draw your earnings as loans from the business, and convert them to dividends and salary at a later date. Operating an overdrawn loan account in this way can have tax advantages when used correctly. Particularly where the company owes you money, as drawings can then be taken without any tax implications. In the event of insolvency, however, it can also leave you personally more exposed.

 

Tax implications of a DLA

There are various tax implications if you operate a DLA.  The money you take out of the company is effectively tax free, but it must be paid back within 9 months of the company’s accounting year end.  Otherwise, HMRC will charge the company 32.5% of the loan value.

Therefore, you need to consider the timing of a loan so you can benefit from the repayment date.  For example, if you take a loan on the first day of a company’s accounting year, you will have 21 months before it needs repaying to avoid the added corporation tax charge.  If however, it is is taken on the last day of the accounting year, you would only have 9 months to repay it before the charge became payable.  If the 32.5% charge does become payable, it will be added to your corporation tax, and is therefore repayable by the company.

If however, you borrow more than £10,000, HMRC considers this a ‘benefit in kind’.  In this case, you’ll need to pay income tax on the loan personally.  In addition, the company will have to pay Class 1A National Insurance.

 

Personal liability of overdrawn loan accounts

Remember that a company is a separate legal entity to its directors, and any money earned by the company belongs to the company, and not to its directors.  Therefore, you should only operate loan accounts on a short term basis.  If you find that your loan account is continually overdrawn, it may be beneficial to reduce it, or clear it by declaring it as salary or dividends (where profits allow).  Although this incurs higher personal tax liabilities, it reduces the risk to the directors and shareholders should the company enter a formal insolvency process.

Ultimately, it’s worth bearing in mind that if your company enters liquidation or administration, you and any other directors will be required to repay any outstanding loans personally and in full.  When a company is struggling financially, its directors will need to weigh the risk of tax advantage over being held personally liable for the full balance of any loans. Even when entering into a Company Voluntary Arrangement, HM Revenue & Customs and likely other creditors will require you to repay the loan into the arrangement to repay creditors.

See our guidance: directors loan accounts within liquidation for details of how liquidators treat overdrawn loan accounts.

Have we answered all your questions about director’s loan accounts?  If we have missed anything, get in touch with one of our business rescue experts directly.

 

Business Rescue Expert is part of Robson Scott Associates Limited, a limited company registered in England and Wales No. 05331812, a leading independent insolvency practice, specialising in business rescue advice. The company holds professional indemnity insurance and complies with the EU Services Directive. Christopher Horner (IP no 16150) is licenced by the Insolvency Practitioners Association

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