What is a director’s loan account?

Table of Contents
    Add a header to begin generating the table of contents

    As a limited company director, managing your personal and business finances is challenging, especially in the early days when you are trying to get your business off the ground. You may be wondering, “Can I take money out of my company for personal use?” or “Can I loan my company money?” The good news is, yes, you can.

    A limited company director can borrow company money or lend money to the company via a director’s loan account. Proper management is vital, as an unpaid director’s loan can lead to tax charges and penalties for the company and the director.

    Understanding the responsibilities and risks and knowing how to repay a director’s loan is essential to avoiding tax implications and penalties. This guide will tell you what you need to know so that you can manage your director’s loan account with confidence.

    For personalised advice, please get in touch with Jameco Group.

    What type of account is a director’s loan account?

    Unlike a sole trader, where personal and business finances are intertwined, a limited company is a separate legal entity from its director. As such, any personal withdrawals by the director must be meticulously recorded in a director’s loan account and subsequently repaid. It is tracked on the balance sheet and documents all financial transactions between the company and its directors.

    As a director of your own limited company, you no doubt already know that it’s hard to raise capital in the early days. The answer – a director lends money to the business to cover startup costs.

    It can work the opposite way, too – the director borrows money from the business, although this is usually seen in established businesses with larger cash reserves.

    Borrowing money from your company is a great way to cover short-term personal cash flow issues without having to declare further dividends in the accounting period.

    Unlike dividends, you wouldn’t have to pay tax on cash taken from a director’s loan, provided you meet the criteria regarding timescales and amounts borrowed, which we’ll delve into below.

    How does a director’s loan account work?

    A director loan account is essential for tracking any withdrawals between directors and the company that are not classified as salary, dividends, expense repayment money, or money you’ve previously paid or loaned to the company. It is critical to maintain a clear demarcation between personal and business finances and to ensure compliance with legal standards for financial transparency and accountability.

    If the account shows a credit balance, it means the company owes the director money. Conversely, a debit balance means the account is overdrawn, and the director owes money to the company.

    An overdrawn director loan account can also occur when declaring dividends without checking if there are sufficient profits, which is also known as an illegal dividend. The best way to correct this is by allocating the amount of the loan account and ensuring the director repays the funds with their own money.

    When a director lends to their company

    Directors may choose to lend money to their companies, and funds can be withdrawn at any time without restrictions. If interest is charged, it is treated as personal income for the director and as a deductible business expense upon which the business can claim Corporation Tax relief.

    Any interest paid by the company must be reported as income on the director’s self-assessment tax return and is subject to a withholding tax at the basic rate of 20%.

    It’s important to note that the principal of the loan is not subject to tax relief; it’s purely the interest charged.

    When the company lends to the director

    A director may need to borrow money from the company, which has perks but comes with considerations. An overdrawn loan account exceeding £10,000, if interest-free, is treated as a benefit in kind.

    This requires recording on Form P11D and incurs personal tax liabilities for the director and a Class 1A National Insurance contribution by the company.

    Shareholder approval is required credit granted to directors over £10,000 to meet corporate governance standards, except in owner-manager businesses where they are the controlling shareholder.

    Is having a director’s loan account a good idea?

    Having a director’s loan account can be a huge benefit, but it comes with strict rules and responsibilities.

    Let’s look at the pros and cons:

    Benefits of director’s loan accounts

    Flexibility: Director’s loan accounts offer significant flexibility, allowing quick access to an interest-free loan for personal needs without relying on employment income or dividends. This can be helpful for managing cash flow or covering unexpected business expenses without disrupting company finances.

    Clear financial separation: Director loan accounts help to maintain a clear distinction between personal and business finances, simplifying the accounting process. It also provides transparency, crucial for accurate financial reporting and compliance.

    Interest earning potential: By lending money to the company, directors can earn a market-competitive interest rate. This not only provides a return on their loan but also can contribute to the company’s financial health instead of passing on interest to a commercial lender’s pocket.

    Tax planning advantages: Structuring withdrawals and repayments strategically can minimise personal tax liabilities, as there is no tax due on the account as long as it is kept within guidelines.

    Disadvantages of a director’s loan account

    Tax complications: If loans are not repaid within nine months and one day after the company’s year-end, they can attract additional Corporation Tax charges. Furthermore, an overdrawn account might be treated as a benefit in kind, triggering income tax and National Insurance liabilities.

    Financial risk: If a director borrows too much money, it can adversely affect the company’s cash flow and overall financial health, especially if the company is nearing insolvency. The director may also face personal bankruptcy if the company enters liquidation, as the liquidator may demand that the director pay the company’s creditors.

    Legal risk: Director’s loans are subject to strict legal regulations, and non-compliance can result in severe penalties, including the potential disqualification of the director.

    Potential for conflict: If loan terms are not transparent, they may be perceived as unfair by other stakeholders or shareholders.

    In summary, while director’s loans offer flexibility, they require meticulous management to avoid financial difficulty, tax implications and even legal action. Good record-keeping and investing in professional accounting services is highly recommended.

    How do I add a director’s loan account in Xero?

    Xero’s standard chart of accounts template includes a director’s loan setup on the balance sheet.

    To enable it and add it to your watchlist, follow these steps:

    Step 1: Log in to your Xero account and navigate to the ‘Accounting’ tab at the top of the dashboard.

    Step 2: Select ‘Chart of Accounts’ from the ‘Advanced’ section in the drop-down menu to access your company’s accounts.

    Step 3: Use the search bar to find the director’s loan account or try entering the code ‘835’, which is commonly assigned to the default director’s loan account.

    Step 4: Click on the account name to open the ‘Edit Account Details’ page.

    Step 5: In the editing interface, check the ‘Enable payments to this account’ option.

    Step 6 (Optional): For easier monitoring, consider ticking the ‘Show on Dashboard Watchlist’.

    Step 7: Save your changes by clicking the ‘Save’ button.

    Here at Jameco Group, we’re well-versed in Xero accounting software, so we can guide you every step of the way.

    Get advice on director’s loans from Jameco Group today

    Our accountants are here to provide the guidance you need to ensure financial compliance and optimise your business strategy.

    If you’re uncertain about the best way to manage withdrawals from your business or need clarity on the tax impacts of your director’s loan account, do not hesitate to contact Jameco Group.

    Frequently asked questions – what is a director’s loan account?

    How long can you have a director loan account?

    It can be maintained indefinitely as long as it complies with any stipulations outlined in your company’s Articles of Association or Memorandum of Association.

    However, critical timelines must be considered to manage the company’s cash flow effectively and mitigate tax implications for the director (see above).

    How do director’s loans affect corporation tax?

    Money lent to your company does not incur Corporation Tax, as these funds are considered a form of internal financing. Interest charged on the loan amount from the director to the limited company is eligible for Corporation Tax relief.

    Note that tax relief is only on the interest amount, not the loan itself.

    What is the 9-month rule for director’s loans?

    If the director’s loan account (DLA) is overdrawn at the end of the company’s financial year and not settled within nine months and one day, the company may face a 33.75% Corporation Tax charge under Section 455 if the overdrawn balance exceeds £10,000.

    Additionally, the amount is subject to 2.25% interest per annum, calculated on a daily basis. The charge is reclaimable 9 months and 1 day after the accounting period in which it was repaid leading to potential cash flow problems, the interest itself is not reclaimable.

    What is the 30-day rule for a director’s loan?

    The 30-day rule for directors’ loans states you must wait 30 days after repaying one loan before taking another. HMRC considers circumvention of this rule as tax avoidance.

    How much interest do you pay on a director’s loan?

    HMRC’s official rate of interest on directors’ loans for the 2024 tax year is 2.25% per annum, charged daily.

    Learn more about taking money out of the business here:

    James Wheeler, founder and managing directors of Jameco Group
    James Wheeler

    James has over 10 years of experience in accountancy and taxation. He has a real passion for business and truly believes SMEs are the heart of the UK economy. In 2017, he founded Jameco Group to provide first-class accountancy, taxation, and business advisory services to individuals and SMEs across the UK.

    Request a Callback

    Fill out the form below and one of our team members will call you back about your query…

    Related Posts

    Let's Work Together!

    Whether you’re requesting a quote or you just have some questions, feel free to get in contact with a member of our team. Please complete our website contact form for a message or call back. We aim to respond quickly.