What about the director's loan account?
In most small businesses, a director will often spend money on behalf of his company or conversely have the company pay for personal items. While in theory it would be better to not do that, it does happen and when it does it's important to record those transactions properly in the accounts.
That's what the director's loan account is for. It's also sometimes called an expense account or a director's current account. Its role is to record money due to or due by the director. Typically, if a director uses cash or his personal credit card to buy items for the company, that account would be credited by the corresponding amount. Conversely, should he buy some personal items using the company credit card, that account would be debited. In that case the net effect is that the company would have lent him some money. This is where the name comes from.
In theory, an overdrawn loan account where the director has taken more cash out of the company than he is owed is illegal under the Company’s Act, although there are no fines payable for breaking this aspect of company law. This was created to protect shareholders from directors taking money out of the business without proper due process. For small companies, the risk of prosecution is very small.
However, the tax implications are real. They are:
- If the amount lent to the director goes over £5,000, this loan is then considered a benefit in kind and needs to be reported onto the form P11D for that director. Even if interest is paid, it would still be considered a benefit if the interest rate paid is lower than the official HMRC rate which tends to be way above market. It is currently at 4.75%.
- If the loan is not fully repaid 9 month after the year end, 25% of the outstanding balance is due as extra corporation tax. That money can be recovered once the loan is payed back but that process can be painful and usually if you find yourself in that situation it's because you have cashflow problems in the first place so you will usually be better off clearing off that loan. Some people will tell you that you can just pay back the loan and borrow again a few weeks later. HMRC will look through those arrangements however, so be warned! Check with your accountant.
As long as you avoid those pitfalls however, you should be fine.