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.
Table of contents
- 1. How Do You Put Money Into Your Limited Company?
- 2. What is a Directors Loan Account?
- 3. Examples of Directors Loans
- 4. Tax on Directors Loan
- 5. Directors Loan Accounts and the Balance Sheet
- 5. How to Charge Interest on a Directors Loan
- 6. How to Write off a Directors Loan Account
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:
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:
- Personal funds invested such as start-up money or to help with cash flow;
- Purchases made on behalf of the business using personal funds for example, products or assets like a laptop;
- Business travel expenses paid personally but not claimed;
- Payroll salary payments not taken during the year;
- Dividends declared but not paid;
- Payment of self-assessment tax from the Company bank account;
- Personal expenses paid for from the business bank account or company credit card.
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.
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.
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
- 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.