When we talk to directors about how to take money out of a company, the concept of the Directors Loan Account (DLA) is often mentioned. This is where the director lends money to the company, which may be for short term investment, to pay wages or to introduce assets to the company.
Conversely, an overdrawn DLA is where a company lends money to a director, either directly or by paying for his personal liabilities. In this situation the following 2 tax issues arise:
- Firstly, a benefit in kind is due on interest free loans in excess of £5,000: either income tax is payable personally by the director on the taxable benefit (through a P11D) or the company charges interest to the director, which increases the loan.
- Secondly, if the loan is not repaid within 9 months of the accounting period end, a corporation tax liability of 25% of the overdrawn amount is paid by the company. This tax is, however, repayable by HMRC 9 months after the end of the accounting period in which the loan is fully repaid.
Obviously both of these issues should be avoided; the interest is a cost and the 25% tax can create significant cash flow problems.
This position can arise quite frequently given the current tax efficient advice of taking a small salary and the balance of funds required to live on as a loan, or when the director effectively uses the company bank account as their own personal bank account, which should be discouraged where possible.
Usually the easiest way to repay the overdrawn loan account is by voting a dividend which is credited to the loan account, in the absence of funds available to repay to the company. However, this carries a risk; if the company has insufficient retained profits or reserves, it will be unable to declare a dividend. Therefore, we recommend that the situation is monitored and controlled.