What is a director's loan account?

How does a director's loan account work?

A limited company's money is not the director's money, however small the company. Every pound that crosses between them has to be one of four things: salary through PAYE, a dividend properly declared, reimbursement of a business expense, or a loan. The loan account is where the fourth kind is tracked.

It runs in both directions. A director who puts personal money into the company at the start, or pays a company bill from their own card, is owed that money back: the account is in credit. A director who draws money out that is not salary or dividend owes it to the company: the account is overdrawn.

An overdrawn account is where the tax rules bite. If it is still overdrawn nine months and one day after the year end, the company pays a temporary tax charge on the balance at a rate on gov.uk, refunded once the loan is repaid. Larger overdrawn balances can also be a taxable benefit for the director, and interest-free loans above a threshold need reporting.

What does it look like in practice?

A consultant puts £5,000 of her own money into her new company's bank account to get it going. The loan account shows the company owes her £5,000. Six months later, with the company in profit, she transfers £5,000 back to herself. No tax, no paperwork beyond the entry: it is her money coming home.

In March she transfers a further £2,000 to cover a personal bill, without declaring a dividend. The account is now £2,000 overdrawn. Her year end is 31 March, so she has until 1 January to clear it.

In June the company declares a £2,000 dividend, which is credited to the loan account instead of paid in cash. The balance is back to nil, and there is no charge. Had she forgotten, the company would have paid the temporary tax in January and waited for the refund.

What do people get wrong?

• —Treating the company account as a personal one and sorting it out later. Later is the year end, and by then the balance is large and the options are fewer.
• —Repaying the loan just before the deadline and drawing it out again straight after. HMRC has specific rules against this, and it does not work.
• —Forgetting money they put in. A credit balance is money the director can take back tax-free, and it is often overlooked.
• —Not recording expenses paid personally, which understates both the company's costs and what it owes the director.