How to avoid an overdrawn directors loan account
Posted on 29th Apr 2022
What is a Directors Loan Account & how can I avoid it being overdrawn?
The truth is many directors of a small business don’t actually understand the numbers in their accounts. One of those numbers is the Directors Loan Account (or DLA for short).
Many of those same directors also find it hard to separate themselves from their limited company. They believe that as it’s their company all the assets of the company (including the cash in the bank) are theirs too.
However, this is not the case, as a limited company is a separate legal entity.
When a director just takes company cash AND they don’t understand how the DLA works then they could suddenly find themselves with a large tax bill that they never even saw coming.
So, to help you avoid that surprise tax bill this article outlines what a DLA is, what the tax consequences are, if it becomes overdrawn and, crucially, how to avoid it becoming overdrawn in the first place.
What is a Director’s Loan Account (DLA) ?
A DLA is where you keep track of all transactions between the company and each of its directors.
Those transactions can include: cash taken out of the company, personal expenses paid by the company, salary, dividends, cash introduced into the company and business expenses paid by the director personally.
To get the DLA balance just add up all the transactions which have been recorded in the DLA.
IF the amount of cash taken out is MORE THAN what is owed by way of salary, dividends, etc. then the DLA will be overdrawn.
In the Balance Sheet of the accounts the overdrawn DLA balance is shown as a company asset. This is because the company has essentially made a loan to the director – it will have to be repaid.
IF, conversely, the amount of cash taken out is LESS THAN what is owed by way of salary, dividends, etc. then the DLA will be in credit.
In the Balance Sheet of the accounts the DLA balance is shown as a creditor of the company. This is because the director has essentially made a loan to the company. That loan can be repaid to the director and there will be no tax to pay on the loan repayment.
When & why might a Director’s Loan Account become overdrawn?
As mentioned above the DLA is overdrawn when the amount of cash taken from a company is more than what the director is entitled to take by way of salary, dividends, expenses and capital introduced.
The 4 most common ways this happens are:-
- A loan is taken out by the director from their company rather than take out a personal loan which will repaid over time.
A director may decide to do it for two reasons. Firstly, it is quick and relatively easy to do. Secondly, it may save the director money if the interest rate charged by the company is less than that charged by the credit card or loan company.
BUT until the loan is repaid then the DLA will be overdrawn.
- The profits are not high enough. Dividends can be declared out of company profits but only after corporation tax has been paid. Many companies declare dividends during the year which are credited to the DLA and essentially are offset against the cash taken out.
BUT A problem may arise if the company profits fall meaning smaller dividends being declared. If the smaller dividend is less than the amount of cash taken out of the company then it is likely that the DLA will become overdrawn.
- The company pays a lot of personal expenses of a director. Any such expenditure must be re-imbursed by the director back to the company – either through a cash repayment or a dividend.
BUT A problem may arise if the director loses track of the amounts involved. Then, come the end of the year, the total is found to be much larger than the director thought BUT there isn’t enough after-tax profit to declare the dividend needed to re-imburse the company.
- There are unexpected / unplanned personal bills at home. Some personal expenditure (e.g., repair bills, surprise holidays, new car, etc.) is either unplanned or unexpected. Either way it requires cash – cash which could come from the company.
BUT A problem may arise if the company profit isn’t high enough to declare an amount of dividend which is the same as the one-off personal bill. If this happens then the DLA will become overdrawn.
How to repay an DLA overdrawn balance
To repay the DLA more ‘money’ needs to be credited to the DLA than the amount of cash being taken out of it.
As mentioned those credits include: salary, dividends, business expenses paid personally by the director and cash introduced into the company.
To illustrate let’s use some figures in an example.
Let’s say, at the start of the month a director has overdrawn DLA balance of £5,000 and needs to take £4,000 cash out of the company to pay the bills at home. That director wants to repay the whole of the £5,000 overdrawn DLA balance by the end of the month…but how?
DLA balance (at start of month) £5,000 overdrawn
Add Cash needed in month £4,000
Less Monthly salary – £1,000
Less Business expenses paid personally but not yet claimed – £2,000
Dividends which need to be declared to reduce DLA to £nil – £6,000
So in this example a dividend of £6000 would have to be declared to clear the overdrawn loan balance (but only £4000 of cash could be taken out by the director).
What are the tax implications of an overdrawn directors loan account?
HMRC does not like directors ‘borrowing’ money from their own company. As a result, HMRC have rules which discourage this from happening. These rules mean tax may become payable if a DLA is overdrawn on the last day of the company’s financial year.
The 2 possible tax implications of a DLA being overdrawn are….
1 BENEFIT IN KIND (BIK)
IF certain conditions are NOT met then an overdrawn DLA balance will be treated as a beneficial loan to the director.
If that happened then the BIK value would have to be calculated and reported on a P11D form. That may result in tax being due – the director may pay income tax and the company may pay class 1A National Insurance.
To avoid a BIK and therefore a tax bill on an overdrawn DLA three 3 conditions must be met :-
- The DLA must be overdrawn by less than £10,000.
- Interest must be paid on the DLA balance
- The interest rate charged is NOT less than HMRC’s official rate for beneficial loans.
2 S455 TAX
A tax charge (known as s455 tax) is payable on any DLA balance which is overdrawn at the end of the financial year. To calculate the s455 tax payable the DLA amount is multiplied by a rate of 32.5%.
The s455 tax payable on a £20,000 overdrawn DLA balance is £6,500 (being 32.5% x £20,000).
This tax charge is included on a company’s corporation tax return with the tax being due for payment 9 months and one day after the end of the company’s financial year.
The s455 tax charge could be avoided….
IF the overdrawn DLA balance is fully repaid within 9 months of the end of the company’s financial year. EVEN IF only part of the overdrawn DLA balance was repaid within the 9-month period then the amount of s455 payable would be reduced.
Let’s say £10,000 of a £20,000 overdrawn DLA balance was repaid within 9 months.
Then the s455 tax payable would be reduced from £6,500 down to £3,250 (being £20,000 – £10,000 x 32.5%).
The s455 tax charge can be REPAID BACK to the company….
The s455 is essentially a ‘tax deposit’ paid to HMRC. That’s because all the s455 tax paid can be reclaimed back from HMRC but only when the overdrawn DLA balance has been repaid.
How can I avoid a Director’s Loan Account becoming overdrawn?
To avoid a surprise tax bill at the end of the financial year then a director needs to ensure that their DLA is not overdrawn.
At times for some, this can be easier said than done. But here are some practical things you can do to avoid this from happening to you.
- Work out how much cash is needed each month to live your life and pay the bills at home.
To do this go through your bank and credit card statements for a month and make a list of what you spend your money on (e.g., mortgage, car payments, etc.) and total it up.
That total figure is the amount of profit (after tax) that your company needs to make each month so that you can pay for the lifestyle and bills at home. Having clarity on this number will also make it much easier to budget and plan your finances.
- Work out how much the sales need to be each month
To do this you need to have clarity on the total overheads (i.e., running costs) of your business in a typical month AND the gross profit margin percentage.
By knowing these two numbers along with the required profit number you will then be able to calculate the monthly sales target. When achieved those sales should generate enough after-tax profit to allow enough dividend to be declared to avoid an overdrawn DLA.
- Have accurate and up to date numbers
By ensuring the bookkeeping is done regularly and kept up to date means you know what your sales, profit and DLA balances all are….and therefore if you’re on track or not.
If you know during the year the profit is less than what it needs to be then you still have time to take corrective action to get you back on track.
- Avoid paying personal expenses directly from your company
By keeping your personal expenditure out of the company makes it so much easier to manage the finances – both at home and in the business.
In keeping everything separate it means you can see how much your personal expenditure is and therefore what the after-tax profit really needs to be to avoid an overdrawn DLA.
So now you know the answer to the question “What is a Directors Loan Account?”
If you’d like some more help when it comes to the DLA then check out our video here…
…Or ping us an email at firstname.lastname@example.org or give us a call on 0161 410 0020 and we’ll be happy to help!
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