The money in your limited company bank account belongs to the company, however as a director of the company you can make withdrawals using what is known as a director’s loan.
The main difference between registering a limited company and self-employment, is that a limited company is an entity in its own right. An individual can own part or the whole limited company, but an individual is not the company. A company pays its own tax called corporation tax and money taken out or paid to individuals is taxed separately on their personal income. So, we must take both limited company and personal tax into consideration. It’s important to understand your relationship with the business as legally separate. A limited company has its own statutory obligations and accountability and for this reason, everything taken out must be recorded in your business accounts.
What is a Directors Loan Account?
HMRC defines a director’s loan, as any money taken from your company that is not classified as follows:
- expense repayment
Nor money you’ve previously paid into or loaned the company. All other withdrawals from your business bank account need to be recorded in your Directors Loan Account (DLA). If your business has more than one director, each director needs to have their own personal DLA.
As long as your personal DLA remains in credit, the company owes money to you and you don’t have to pay any tax. However, if your personal DLA has a debit balance, this means that your DLA is overdrawn and you owe money to the business. Effectively the balance is an interest-free loan which may need to be reported to HMRC as a benefit in kind – we’ll cover this later.
At the end of the financial year, you will either owe money to the business or the business will owe money to you. This needs to be recorded as an asset, or a liability within the balance sheet of your business’s annual accounts.
Directors Loan Account Record
You will need to record the following items in your DLA records:
- Any cash withdrawals from the company that you’ve made as a director
- Personal expenses which were paid with company money or credit card
- Business expenses must be incurred wholly, exclusively for the purposes of the business
Anything you purchased using company resources that does not meet this criteria is therefore a personal expense. Allowable expenses are the essential costs of running your business that are tax deductible. Any outgoings that are allowable expenses can be deducted from your taxable income, allowing you to save money and reduce your tax bill. Keeping a good tax record will help you be tax efficient by deducting all of your allowable expenses before you submit your profits to HMRC. Allowable expenses aren’t considered part of a company’s taxable profits. You therefore don’t pay tax on these expenses. Only certain costs can be claimed as allowable expenses. This is a potentially risky part of running your own limited company and HMRC will review your DLA throughout the financial year to ensure their rules and guidelines are being correctly followed. Prestige Business Management can help advise you in this area, personal trainers for example can claim for certain types of clothing whether it is branded or not. The important thing to remember is that any money from your business that you use for a personal reason, still belongs to the business and acts like a loan to you personally. The loan hasn’t been subject to tax and HMRC will require tax to be paid on the correct amount of profits for your business. Which is why good record keeping is paramount.
Overdue Payment of a Director’s Loan
You may need to pay tax if your DLA is overdrawn at the date of your business’s year-end. If you pay back the director’s loan in full within nine months and one day of the business’s year-end, you will not owe any tax. For example, if your DLA is overdrawn at a year end date of 30th April 2022, this amount must be paid back by 1st February 2023. An overdue payment of a director’s loan will incur additional Corporation Tax at 32.5% on the amount outstanding. This further amount is repayable to the business by HMRC once the director’s loan is repaid to the business by the director. If you do not repay your director’s loan, you may be required to pay personal tax at 32.5% of the loan amount. This will not then be repaid by HMRC when you pay the loan amount back to the company.
Benefit in Kind
The business will have to pay employers national insurance contributions at 13.8% of any benefit in kind provided, including the director’s loan. A director’s loan will be classed as a benefit in kind if you owe your business over £10,000 (interest-free) at any given time. In this car you will need to record it on a P11D form. This is because this will be liable to both personal and company tax. Your company will also need to pay Class 1A National Insurance at the 13.8% rate on the full amount. Usually shareholder approval must be given for loans of more than £10,000. In most small businesses, a director will also be a controlling shareholder, so the approval is more a formality rather than a legal obligation. The business will not have to pay Corporation Tax on any money you personally lend to it and you can withdraw the full amount from the company at any time. If you charge interest on this loan from you to the business, this will be classed as a business expense and become a personal income for yourself. In this case the interest amount must be declared as income on your Self Assessment and tax paid accordingly.
Bed and Breakfasting
The government introduced measures to stop directors managing their DLAs in a way that means they might avoid tax. This practice is known as ‘bed and breakfasting’ whereby the perpetrator repays their director’s loan amount back to the business before year end to avoid penalties. Yet then takes the loan out again after the deadline, with no real intention to repay the director’s loan at all. When a loan amount over £10,000 is repaid by the director, no further loan over this amount can be withdrawn within 30 days. When this happens, HMRC’s view is that the director doesn’t intend to pay the money back and the full amount will automatically be taxed. The ‘bed and breakfasting’ of a loan which falls outside of the 30-day rule, may still be subject to tax where the loan is over £15,000. The law states that if you make a repayment towards your director’s loan of more than £15,000 within 30 days, and intend to take a new loan of over £5,000 in the future, the ‘bed and breakfasting’ rules will apply. Any patterns of repeated withdrawals or similar sums being withdrawn could be interpreted as an intention by HMRC. If your business writes off a director’s loan, there are both tax and accounting implications. There are comprehensive rules about the length of a director’s loan, repayments and any interest being charged or received. Talk to Prestige Business Management to ensure that you understand your rights and obligations, and that if you are using a director’s loan you are doing so cost effectively.
At Prestige Business Management we can help your Business
At Prestige Business Management we can help you with all your tax and accounting needs. Find out what we can do for you. Call us today on 0203 773 2927.