A director’s loan account cannot be used by sole traders. It is, as the name suggests, a loan account for company directors.
It is important to note that a director’s loan account is not the same as your business bank account or your personal bank account. Instead, it is a “virtual” account that only exists as a means of keeping track of the money that flows between you and your company. This is because, unlike sole traders, your limited company is separate from you.
What this means is that the money your limited company earns belongs to the company, not to you. Of course, there are ways for you to withdraw money from the company, and the director’s loan account keeps track of this.
Moving money in and out of a director’s loan account
You can move money in and out of your company using your director’s loan account to track it.
If your company needs some financial help, which is often the case when starting out, then you could put some of your own money into the company bank account. Your company would then owe that money back to you.
You can loan your company money in other ways too, for example by purchasing items for the company with personal funds. Any personal money you give and/or spend on the company will be recorded in the director’s loan account as money owed to you. This is also the case if you choose not to take your salary when times are tight – that counts as money the company owes you. You can take this money back at any time if the company has enough funds. You are the creditor and you can take repayment.
If you decide to take money out of the company’s bank account, this means you are borrowing money from the company via a director’s loan – assuming the money you are taking out is not a loan repayment or your salary.
It’s important to watch how much money you are taking from your company through a director’s loan account. If you overdraw your director’s loan account by more than £10,000 (HMRC can change this amount) then it can be classed as a benefit as you are getting a loan from your company without paying any interest. This means you must declare it on your personal tax return and pay income tax. You can avoid this by paying interest in your director’s loan equal to or in excess of the rate demanded by HMRC.
This is particularly important to bear in mind if you use your director’s loan account to lend to others as well, such as your spouse, relative or anyone else closely connected to you.
You will owe any money you took from the company at the year end, as you will pay dividends after tax. Make sure your company has enough profit left over after paying your taxes so you can clear your director’s loan account. Otherwise, if you have an overdrawn director’s loan account you must declare this on your Corporation Tax return and pay even more tax. The current rate of tax on the director’s loan is 25%.
However – it’s important to note that if you are able to repay your overdrawn amount within nine months and one day of your accounting year end, then you will have no additional tax to pay. Even though you will still have to declare the loan on your Corporation Tax return, you will get tax relief on the amount. HMRC have ensured that directors cannot circumvent this measure by taking the money out again as soon as they have paid it. If you withdraw the amount you repaid within 30 days, the loan counts as unpaid.
The company can also write off a director’s loan. However, the loan must be formally waived, and the amount written off is treated as a deemed dividend. However, in many cases HMRC will seek to collect Class 1 National Insurance Contributions from the company as a result, as the loan may be seen as an emolument. You will need to include this in your self-assessment tax return.
Be aware that if you borrow too much money from your director’s loan account, you could force your company into liquidation.
Overdrawn accounts in liquidation
If your company goes into liquidation while your director’s loan account is overdrawn, the liquidator can demand that you repay the amount you owe in order to pay your company’s creditors. If you are unable to pay, the liquidator can take legal action against you, which may even cause you to declare bankruptcy. In such cases, the Insolvency Service may seek to disqualify you from acting as a director in the future.
If you cannot afford to repay all the money you owe and you can prove it, some liquidators may be willing to settle. However, this will depend entirely on the circumstances and what the liquidator deems to be in the best interests of your company’s creditors.
Liquidators can also reverse transactions made by your company if they are deemed to have been bad for the company or not in the best interests of your creditors.