Q. I have recently been advised my accountant that my Directors Loan Account is overdrawn and that both I and the company face additional tax liabilities because of this. What is my Directors Loan Account, how has it become overdrawn and what are the additional taxes I now face?
A. In small and family companies, the directors often either loan money to the company or borrow money from the company. In either case, this can have tax and National Insurance implications. The precise tax consequences will depend on whether the director’s loan account is in credit or overdrawn and the nature of the transaction concerned both during the accounting year and more particularly at the year end.
A Directors Loan Account (DLA) is usually in credit when a business is starting up or to fund expansion plans, the directors may lend money to the business. Where money has been loaned to the business and the director’s loan account is in credit, the director can draw on the credit balance at any time without any tax or National Insurance implications. This is merely a repayment of the loan and not earnings or a distribution. However, be careful because if the company pays interest on the loan, the director will need to declare the interest received on his or her personal tax return and pay tax on that interest.
A director’s DLA may also have a credit balance if dividends or salary payments are credited directly to the loan account rather than being paid to the director. This may be done if the company is experiencing cash flow problems and the director is prepared to wait until the situation has improved before withdrawing their money.
Where a dividend is credited to the loan account, there are no tax implications at the time that the dividend is credited to the DLA or when the director withdraws the money from the account (although the company must have the profits or reserves available to pay a dividend).
Where a salary or bonus payment is credited to the DLA rather than being paid directly to the director, PAYE and NIC are due at the time that the amount is credited to the account and must be paid over to HMRC and recorded on the tax deductions working sheet P11 in the same way as if the director had been paid directly. However, there are no further consequences when the director withdraws the money from the DLA. In this situation, it is the net amount after deduction of PAYE and NIC that is credited to the account.
In reverse a directors DLA may become overdrawn for a variety of reasons. The company may simply lend money to the director, the company may pay personal bills on the director’s behalf or the director may withdraw money in anticipation of a credit to the account, such as a dividend, salary payment or bonus.
If a withdrawal is made in anticipation of a dividend payment, there are no tax (or National Insurance) implications at the time of the withdrawal. However, if the withdrawal is made in anticipation of a fee or a salary, PAYE and NIC are due at the time that the withdrawal is made, but not when the payment is credited to the DLA. The same rules apply where personal bills are paid in anticipation of a credit to the account.
Where the company lends money to the director, benefit in kind implications may arise on the director personally. If the DLA is overdrawn by more than £5,000 at any point in the tax year and the director does not pay interest on the overdrawn balance or pays interest at less than the HMRC’s official rate, a taxable benefit arises. The cash equivalent of the benefit (interest at the official rate less any interest paid by the director) must be returned on the director’s form P11D and the director must pay tax on the benefit.
From a corporation tax perspective, if the DLA is overdrawn at the year end and the company is a close company, the company must provide details of the loan on the company tax return. If the loan is repaid within nine months and one day (i.e. before corporation tax for the period is due), there are no corporation tax consequences. However, if the loan account remains overdrawn, corporation tax at a rate of 25% is payable on the loan. This can be reclaimed when the loan is repaid or written off or released.
If a loan to a director is written off or waived, the amount written off is treated as a payment of earnings on which PAYE and NIC are due.
As you can see DLA’s are a potential minefield and it is important to make sure you understand the rules and that transactions are debited or credited to the DLA at the time that they are made.
Further assistance is available via our specialist tax advisors on 01455 852550.