Transferring funds to and from a business for personal use when operating as a sole trader or partnership is often simple for tax purposes. For a limited company that operates as a separate legal entity, the process of loaning and withdrawing funds from the business requires careful consideration and planning to minimise tax implications.

This article provides a comprehensive guide to understanding Director’s Loan Accounts (DLA’s), taking a close look at the tax implications of overdrawn and credited Director Loan accounts.

What is a Director’s Loan Account?

A Director’s Loan account (DLA) records transactions between the company and its director that fall outside any salary, dividend, or expense repayment. The DLA only applies to limited companies.

The director’s loan account details money borrowed by directors from the company or money lent by directors to the company. These transaction records are collated to establish the balance of payments between the two separate entities and can present potential tax implications.

 

What should a Director’s Loan Account contain?

The director’s loan account can contain the following transactions made by directors or close family:

  • Cash withdrawals from the company.
  • Personal expenses that were paid using company money or credit cards.
  • Cash loaned to the company.
  • Business expenses paid using personal funds.

 

What are the interest rates on Director’s Loan Accounts?

For the 2024/25 tax year, HMRC has set the interest rate for Directors’ Loan accounts at 2.25% annually. This interest is calculated daily. Companies must apply this rate to directors’ loans, treating the calculated interest as theoretical income. Depending on the circumstances, it should be recorded as such in the company’s financial statements or the director’s tax return.

 

What is a Director’s Loan?

A director’s loan is money that is taken from the company by directors or by any member of their close family that does not fall under the following conditions:

  •  A salary payment
  • A legitimate expense repayment
  • A dividend (If the company cannot afford to pay out dividends, but it is still taken, this is classed as a loan and must be repaid)
  • Repayment of a loan previously paid to the company.

Any money withdrawn from the business to directors that does not fall into the above categories legally must be recorded in the directors’ loan account and will eventually have to be repaid.

 

How much can you borrow in a Director’s Loan?

There is no legal limit to the amount that can be borrowed in a director’s loan. Any amount above £10,000 will be automatically treated as a ‘benefit in kind’ and must be reported on a self-assessment.

It is important to consider the impact on the company’s cash flow when taking a director’s loan from the company, as well as the feasibility of meeting the repayment terms. At DS Burge and Co, we can advise on the optimal borrowing strategy that minimises tax liability and aligns with your company’s financial planning, so get in touch.

 

When do you need to repay a Director’s Loan?

To avoid any tax penalties, a director’s loan must be repaid within nine months and one day of the company’s accounting year-end.

It is possible to claim back tax nine months after the end of the accounting period in which you cleared the debt. Alternatively, it might be beneficial to delay the payment of your company’s corporation tax until the director’s loan has been repaid. The corporation tax payment deadline is nine months after the company’s financial year-end, providing additional time to repay the loan.

If you have questions regarding the tax implications of an unpaid director’s loan, speak to one of our team for guidance.

 

What is an overdrawn Director’s Loan account?

An overdrawn director’s loan account occurs when a director’s loan has not been repaid in full to the company. At the end of the company’s accounting year-end, the balance of the director’s loan account (DLA) is collated, considering any money borrowed or lent to the company from directors. Any balance in debt that has not been paid within nine months and one day is classed as ‘overdrawn’ and is subject to a tax liability.

An overdrawn director’s loan account must be reflected on the company’s tax return, reflecting the amount owed. HMRC can question the presence of a director’s loan account at any time as part of the corporation tax compliance checklist; all entries must be accurate and timely.

 

What are the tax implications of an overdrawn Director’s Loan Account?

 

Corporation Tax

An overdrawn director’s loan account that is not paid within nine months and one day will incur a Section 455 corporation tax of 32.5%. This rate is set to match that of a higher-rate taxpayer and is designed to financially discourage directors from taking loans instead of dividends from the business.

 

Benefit in Kind

If the director’s loan exceeds £10,000, the total loan amount is classed as a benefit in kind. Directors will be required to file a P11D form to HMRC, which will result in the company being required to pay Class 1A National Insurance of 13.8%.

In general, most companies require shareholder approval of directors’ loans that exceed £10,000 due to the additional tax requirements for the company.

 

How do you deal with an overdrawn Director’s Loan Account?


It is advisable to settle any outstanding balances on a Director’s Loan account within nine months and one day of the company’s financial year-end. This ensures avoidance of the Section 455 corporation tax.

However, a voting dividend payment could be issued if directors cannot make full payment to cover the balance. In this case, the dividend would be accordingly credited to the Director’s Loan account, diminishing any debts and balancing the account. Income tax on the dividend will be payable in the tax year in which it is voted, potentially presenting a further financing issue for the director further down the line.

Due to the high levels of corporation tax applicable on overdrawn director loan accounts, it might be preferential for directors to seek personal finance to cover any debts owed. This could be preferential for a business that is suffering short-term cash flow issues and is unable to raise any finance, particularly a new business. Using personal finance to pay for overdrawn directors’ loans should be carefully considered, as the director will have ongoing liabilities.

 

Can you repay your director’s loan and take out another straight away?

 

The ‘Bed and Breakfast’ Concept for combatting tax avoidance

In April 2016, HMRC imposed CTM61630 ruling aimed at preventing the avoidance of Section 455 corporation charges on directors’ loans. Before the 2016 HMRC rule change, directors could repay any debt on their director’s loan account just before the nine-month one-day period and then take out a new loan a few days later, effectively restarting the loan period and avoiding any corporation tax applicable.

This was coined as the ‘Bed and Breakfast’ concept by HMRC and is considered a tax avoidance scheme. This change has prevented directors from utilising these schemes to extend loan periods while avoiding corporation tax charges.

 

The 30-day Rule

This rule comes into effect if a director chooses to borrow funds from the company that is £5,000 or greater within 30 days of a repayment. In doing so, the director will still be required to pay corporation tax on the original amount borrowed. In effect, the repayment is considered ineffective and, in essence, borrowed again.

For example, suppose a director makes a payment of £10,000 to repay their director’s loan account within the nine-month one-day period but chooses to withdraw a new loan of £15,000 within 30 days. In that case, they will have to pay corporation tax on the original £10,000. The new £15,000 will incur corporation tax charges unless paid before the 9-month one-day period.

 

The Arrangement Rule

This rule affects loan balances that are greater than £15,000 and is an intention-based ruling. This rule comes into effect if directors have decided to borrow additional funds of £5,000 or more, just beyond the 30-day ruling, to avoid tax. If proven, the total amount of corporation tax will be required for the lower amount borrowed in addition to corporation tax after the nine-month one-day period unless cleared in full.

 

Can a Directors Loan be Written-Off?

Companies and directors can agree to ‘write off’ a director’s loan. This can occur for a variety of reasons, such as liquidation, reducing personal liability and for tax efficiency reasons. For a director’s loan to be written off, the company and the director must follow specific formalities and adequately address the associated tax responsibilities. When a director’s loan is written off, this amount will be subject to income tax and NIC.

 

Tax Implications of a Written-Off Directors Loan

The company’s corporation tax payments under Section 455 still apply to the written-off directors’ loan. However, the company can reclaim this tax from HMRC but only after the nine-month and one-day period has passed. The company cannot reclaim any interest paid on the corporation tax.

 

Income Tax

The director must report the written-off loan on their self-assessment tax return. The loan amount is taxed as a dividend payment rate with an introductory rate of 8.75%, a higher rate of 33.75% and an additional rate of 39.35%.

 

National Insurance Contribution

If the ‘written off’ director loan exceeds £10,000, then the loan is considered as a benefit in kind. As a result, the company is required to pay 13.8% of Class 1 national insurance contributions. However, this is a tax-deductible expense. If the amount is below the official threshold of £10,000, no national insurance has to be paid by the company.

There is no applicable national insurance contribution required from the director due to the treatment of the ‘write-off’ as a dividend.

 

What happens if your Directors Loan account is in credit?

When a Director’s Loan Account is in credit, it means that the company owes money to the director. This credit balance can arise either from a one-time payment from the director to the company, such as an injection of cash to support business operations or cover expenses, or because of a final credit balance resulting from the cumulative transactions over the accounting period. A director can choose to withdraw any credit amounts from the directors’ loan account tax-free or arrange an ongoing interest payment for the amount owed.

 

Interest Payments

Any credit owed by the company to a director will incur interest payments on the total amount in credit. There are no official rules about the stated amount of interest that is applicable, and this is up to the negotiation between the director and the company. However, the company must pay a commercial market interest rate to receive corporation tax relief. The exact commercial rate is likely dependent upon the financial position of the company and its size but can be around 15% per year.

 

Tax Implications

The company must file a CT61 form with HMRC and withhold a basic rate of 20% for taxation purposes every time an interest payment is made to a director. The CT61 form is required 14 days after the quarter in which the interest is paid. To ease the administrative burden, most companies opt to pay interest on an annual basis.

The company can gain corporation tax relief on interest paid for the gross amount of the credit, assuming that the interest rate is based on a commercial market rate. The commercial market rate is considered on a case-by-case basis, but to satisfy HMRC, quoted rate evidence is recommended.

Any interest payments made by the company to the director will have to be declared as income through an annual self-assessment. For some directors who receive dividend payments and have a low company salary, interest receipts can be a tax-efficient payment. If the director is a basic rate taxpayer, they can earn up to £1,000, subject to 0% income tax. For taxpayers with higher rates, this 0% tax rate is reduced to £500.

Any interest payments are classed as savings income; therefore, Class 1 national insurance contributions (NIC) are not applicable.

 

Conclusion

Director’s loan accounts (DLAs) provide a clear and transparent record of financial transactions between directors and the company. As the implications of mismanaging a DLA can be significant, directors and companies must have a thorough understanding of how these accounts operate and the tax consequences involved.

If you are navigating the complexities of DLAs or looking to optimise your tax strategy while ensuring full compliance, seeking professional advice is highly recommended. Our expert team can provide you with the assurance your DLA is managed effectively, so get in touch with us today.