One of the main questions we have from clients when they run limited companies is around directors’ loan accounts. How they work and what they are.
To understand directors’ loan accounts, the key thing to remember is a company is its own separate legal entity and any profits generated by the company belong to the company (not the director). Every transaction between a director and the company is between two separate “persons”. This is completely different to a business run as a sole trader.
When money is taken out of a limited company, therefore, it has to be accounted for within the accounts according to what it is. For example:
- If a salary, it needs to go through the payroll;
- If a reimbursement for business expenses, the director needs receipts as evidence;
- If a dividend (where the director is also a shareholder) the relevant legal dividend paperwork needs to be drawn up and signed at the time;
- It could be rent, if the director owns the trading property; or
- A loan to and from the limited company (this is the directors’ loan account).
Each type of payment has its own tax consequences.
How a directors’ loan account works
The directors’ loan account keeps a tally of the money a director has lent the company, less monies he/she has taken out (which have not been accounted for elsewhere as salary, dividend, rent etc). This running total starts from the first transaction the director has with the company. If, for example, a dividend or a salary is declared correctly, but not taken out in full by the director, this is also shown as monies lent to the company and added to the directors’ loan account.
If the directors’ loan account goes overdrawn (ie more money is taken out of the company by the director then owed to him/her), this can have tax consequences for the director and the company. Tax advice should be sought asap by the company to minimise the effect of this by careful tax planning.
Therefore, regular conversations with an accountant are vital to ensure there is a plan on how money is taken out of the company by the directors. Key considerations include, making sure it is structured tax efficiently and takes into account the dynamics and wishes of the director group.