Directors Loan Accounts Explained

Wondering how to handle directors loans you’ve made to your Limited Company? Or how long you have to repay a directors loan or if you can write it off? Then read on! In this guide, you’ll find some examples of directors loans, how they are handled on the balance sheet depending on whether they are in credit or overdrawn or not as well as the tax implications of charging interest on a debt owed to you.

Updated 30 November 2021

Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.

1. How Do You Put Money Into Your Limited Company?

In most cases, you can put money into your Limited Company by simply transferring money from your personal bank account into your Limited Company bank account**. The important thing is to account for the money you have put into your Limited Company correctly when you do your bookkeeping to ensure you legally log the money in the statutory accounts in such a way that you can repay yourself tax-free and even charge interest on your loan. The way this is done in accounting is using a Directors Loan Account.

** If you’ve formed a Limited Company, then opening a separate business bank account is a legal requirement.

2. What is a Directors Loan Account?

The Directors Loan Account is used in accounting like a virtual bank account to log all the money a Director lends and takes from a Limited Company. They are also known as directors current accounts. Directors loans do not include:

  • Payroll salary payments where there is payslip;
  • Legally paid dividends;
  • Expenses repaid.

3. Examples of Directors Loans

Here are some examples of directors loans taken from or paid to a Company that may need to appear in the directors current account:

Directors must keep evidence to support any loans made to their Limited Company.

4. Tax on Directors Loan

You and your Company do not pay tax on the money you loan to your Limited Company. However, you may pay personal tax and your company may need to pay additional corporation tax (known as an s455 charge) if you have an overdrawn directors loan – which occurs when a director takes out more money from their LTD than they have put in.

5. Directors Loan Accounts and the Balance Sheet

Directors loans are shown on the balance sheet as a debtor or creditor since loans are not considered an income or expense. Where there is more than one Director in the business, a loan account is typically set up for each person in the balance sheet so that each individual can see how they are owed/owe the business, Although there is no legal requirement to separate Directors loans by person.

4.1 Example 1

Eddie puts money into his Limited Company of £10,000 to cover the costs of setting up his business. Business goes well and he decides to repay himself £7,500 of his initial investment. Eddie is owed £2,500 from his Limited Company and his directors loan account will appear as a creditor in the balance sheet.

Example of Directors Loan Account

4.2 Example 2

Eddie puts money into his Limited Company of £10,000 to cover the costs of setting up his business. Eddie repays himself the full £10,000 therefore the loan is cleared in full and there will be no debtor or creditor in the balance sheet.

Directors Loan Account Repaid in Full

5. How to Charge Interest on a Directors Loan

Directors can charge interest on loans they make (similar to if money was borrowed from a bank) but there are tax implications of doing so.

Firstly any interest charged on Directors Loan accounts must be ‘reasonable.’ And although HMRC doesn’t define what ‘reasonable’ means, it can help to look at what the interest rates are being applied on a similar loan would be if the Company were to borrow from a bank or other lender. There are tax implications for charging overly inflated rates of interest on Directors loans and the Director could face paying P11d tax on the additional rate used.

Next, Directors must draw up a loan agreement detailing dates, repayments and interest charges attached to the interest being charged (similar to any other loan). This protects the Director as well as keeping HMRC happy.

Finally, Directors should double-check that charging interest on Directors Loans are permitted under the terms of the articles of association.

5.1 Tax on Interest Charged on Directors Loans

Once the interest terms have been agreed, the loan and interest can be drawn in line with the signed paperwork. The Company will receive corporation tax relief on the amount of interest it pays and must:

  • Deduct income tax on the interest payments at the basic tax rate of 20%;
  • Submit a CT61 to HMRC to let them know what income tax has been deducted from the interest it has paid to the Director.

The Director receiving the interest on their director’s loan must declare the receipt on their self-assessment tax return (making an adjustment for the 20% income tax deducted at source by the Limited Company they’ve loaned money to).

6. How to Write off a Directors Loan Account

There are some circumstances where a directors loan account is in credit (where they are owed money back from a Ltd Company) but they want to write it off. The Director will first need to understand that they are waiving the right to claiming back the money once the account is written off and year-end accounts filed.

The amount being written off will be considered taxable income and should be disclosed as “other income” or “sundry income” in the profit and loss account.

Related:

Taxes are changing! From April 2024 sole traders will need to report their earnings and pay tax on a quarterly basis. This is known as Making Tax Digital, which you can read more about in this guide to help you get prepared.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek and money nerd helping financial DIY-ers organise their money so they can hit their goals quicker.