Directors’ loan account debtor – several traps to avoid

As the Director of a small business you may end up owing the company money – or to put this in more formal terms, the Directors’ Loan Account becomes a debtor balance.  If this debt is small and repaid in a short space of time, it is unlikely to cause you or the company problems, but if the situation persists there are several consequences to look out for.

The debtor may arise for a combination of reasons.  A ‘tax efficient’ salary level may have been decided upon, with further sums drawn from the company that are not formally declared as dividends, or personal expenses end up being taken from company funds.

The consequences broadly fall into tax and legal issues:

  • Employment tax: if the debtor exceeds £10,000 at any point and a market rate of interest is not charged on the loan, then a Benefit in Kind arises, and this must be included on the Director’s P11d for the relevant tax year;
  • Corporation tax: if the debtor remains outstanding at the company’s financial year end, and is not fully repaid within nine months of that date, then tax of 32.5% of the outstanding balance becomes due at that point.  This tax can eventually be recovered if the balance is paid off, but the recovery is not immediate.  Also, care must be taken not to immediately re-borrow funds from the company as HMRC will not regard the loan as repaid in these circumstances;
  • Legal issues surround insolvency matters in particular.  If a Director is borrowing money from the company, and it becomes unable to meet its debts as they fall due, then extreme care is needed.  A major creditor of a small company will often be HMRC and outstanding sums due to them will need careful management to avoid them taking extreme measures to recover sums due.  If the company ends up in liquidation, then any Director owing the company money will become personally liable to the creditors and exposed to their own insolvency proceedings.

In very simple terms, running a continual debtor balance on the Directors’ Loan Account is best avoided.  If you have decided to minimise salary payments for tax planning purposes, then aim to draw any further necessary funds as dividends – but take care to ensure these dividends are legally declared!

This can be tricky subject but with careful planning and monitoring the pitfalls are avoidable.  If you contact us we can discuss your situation in more detail, and any initial meeting will be free of charge and with no obligation.