How can a Directors’ loan account become overdrawn?
A Director/Shareholder might put money into their own limited company and then later they pay themselves back. This movement is shown in the accounts as money coming into the limited company as a loan from the Director, and then money going out of the limited company to pay the Director back.
A Director/Shareholder earns income from the limited company by running some income through payroll, and then taking other income as a dividend. The payroll amount should be the most tax efficient amount available and net pay is shown on the payslips.
The second way a Director takes income from a limited company is by taking a dividend. The dividend amount is profits minus accountants’ adjustments, minus corporation tax = available for dividends.
If the owner of a limited company takes for their own income, more than is available as money owed to Director + wage + available dividend, this creates an overdrawn Directors loan account.
Tom lends his limited company £2000 for machinery. His net wage for the year was £9600 and his accountant advises him that there is an available dividend at the end of the year of £25000. The total money that Tom can take out of the business for his own household is:
£2000 owed to Tom for machinery.
£9600 net wages for the year
£25000 dividend for the year
Tom has already taken out of the business £48000 by the year end.
This means Tom has taken £11400 more than was owed to him and now he has an overdrawn Directors’ loan account, he owes £11400 back to the business. It is like a bank account. If you have £3000 in your bank but you take out £4000, you will be £1000 overdrawn and owe that money back to the bank. Tom has technically taken a loan from his company.
How can you pay back an overdrawn Directors loan account?
- Put the money back into the business from your own personal bank accounts.
- Take less dividend than is owed to you in the next year, to offset the amount taken too much in the previous year.
- Speak to your Accountant about the tax implications of increasing your wage in line with extra tasks you are completing. Then use the pay rise to pay the company back for any amounts overtaken in the previous year.
What are the tax implications of having an overdrawn Directors loan account at the year end?
If the Directors’ loan account was repaid within the same financial year as it was overdrawn, you only need to consider the P11d implications mentioned below. There is no other additional tax to pay because you have repaid the loan account within the same year as it was overdrawn.
If you still owe the money back to the business after the year end, but you repay the overdraw Directors’ loan account within 9 months and 1 day after financial the year end, a declaration is made in the corporation tax return and you will not have to pay any additional tax.
If the Directors’ loan account is still outstanding 9 months and 1 day after the financial year end, corporation tax is charged at 32.5% (from 2020/2021) on the amount outstanding. This additional corporation tax can be claimed back from HMRC if the Directors’ loan account is paid back within 4 years.
How do I reclaim the corporation tax once the Directors’ loan has been cleared?
If the Directors’ loan account is cleared within 2 years of the end of the accounting period when the loan was taken out, you can reclaim the extra tax paid, within the corporation tax return done for either of the next 2 years.
If the Directors’ loan account is cleared after 2 years, a form L2P is completed to request a refund of the extra corporation tax paid on the overdrawn Directors’ loan account. Corporation Tax: reclaim tax paid by close companies on loans to participators (L2P) - GOV.UK (www.gov.uk)
Tom owed his company £11400 at year ending 31.3.2021 so Toms’ limited company paid £3705 extra corporation tax (£11400 x 32.5%). By 31.1.2024 Tom has repaid the £11400 and his Directors loan account is no longer overdrawn. Form L2P is completed requesting a refund of the extra £3705 tax paid.
Is there any other tax to consider other than corporation tax?
Each year you have to consider, was any interest paid to the limited company for the loan.
If at any point within the year, the Directors loan account was overdrawn by more than £10000 (the £10000 limit is as per 2020/2021) and you did not pay the official rate of interest to the company on the loan, or you paid a reduced rate of interest, the company will pay employers national insurance on the interest not charged and the Director will pay income tax on the same amount.
The reason for this is, if in Toms’ case above he had borrowed £11400 from a bank, he would have paid interest on the loan. By borrowing the money from his limited company Tom has decided not to pay the official rate of interest to the company (official rate of interest is specified by HMRC each year). Tom has received an interest free loan (or a reduced rate of interest if interest rate charged was below the official rate set by HMRC). Tom has saved the value of the interest not charged and this saving is treated as taxable income by HMRC.
Example: for 2020/2021 the official rate of interest was 2.25%
Tom had a loan of £11400 x 2.25% = interest is £256.50
As Tom paid no interest the limited company will pay employers national insurance on the £256.50.
Tom will include the £256.50 as a benefit in kind on his tax return and pay income tax on the amount.
The above declaration is made every May on a P11d Benefit In Kind form.
What should I be doing so my Directors’ loan account does not become overdrawn?
Keeping your bookkeeping up to date is essential.
Investing in monthly or quarterly management accounts would help you to see where your business is at least quarterly, and allow you to see within the year, rather than just at the end of the year, how money earned compares with money withdrawn. This timely knowledge will help you to keep on top of your Directors loan account and run your business much more efficiently.
If we can help in any way, please get in touch. A little bit of knowledge lights our way.