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After years of attempting to explain the “ins and outs” of a Directors Loan Account, I thought that it would be a great subject to write a blog on seeing as it confuses so many Directors.

MH 201115 Est 33When explaining to clients about what it all means, I find myself raising my right arm and attempting to hold on to something hanging from the ceiling – this is because I always explain it as an intangible pot of money (I usually receive quite a confused look from my client as if to say “what are you doing?” but please bear with me – you’ll see why). It’s like a bank account only, you can’t touch it and you don’t receive statements but – it exists! “Debits from it” reduces the balance and “credits to it” increases it.

If, as a Director, you personally pay money in to your limited company – you credit your Director’s Loan Account. This means that you can take it back out of the company at any point (TAX FREE!). But, if you draw money out of the company, this will reduce that credit that you have already built up.

There are ways of crediting a Director’s Loan Account, such as claiming mileage. If your motor vehicle isn’t an asset in the limited company, it may be more beneficial to claim 45p per mile (for the first 10,000 miles and 25p per mile thereafter). I have found that most Directors don’t tend to reimburse themselves straight away, but by keeping a detailed mileage log, you can claim the mileage cost as a deduction of profits (therefore reducing your corporation tax) but also credit your director’s loan account because you have not yet reimbursed yourself.

By building up a pot in your Director’s Loan Account, it gives you the freedom to take money out of the company in the future tax-free (maybe you are planning on putting down a deposit for a house or you are finally giving in to your kids requests for I-pads!).

Be warned – this can go the other way! You can only take out what it available in the company as reserves. Reserves are typically:

What is left in the company from the previous year

Plus: the net profit from this year

Less: the corporation tax payable on the above profit

Less: any dividends voted this year

Dividends can only be voted when there are enough reserves in the company to vote them. If you draw out too much money from the limited company, you could be left with an overall “debit” on your Director’s Loan Account (there weren’t enough credits to keep it positive) a debit means that it will appear as a debtor on the company’s balance sheet which means that you (the Director) owe the company money. If this is the case, you are looking at a Section 455 liability as well as a potential P11d benefit (because you have received an interest-free loan from the company) if the loan is higher than £10,000 at the end of the tax year.

A Section 455 liability is 25% of the Director’s Loan Account outstanding at your year-end. Thankfully, this is repayable to you once you have paid it back to the company. The tax on your P11d however, will not be repaid to you.

As a sole trader, you don’t need to worry about any of this – your money is your money. If you trade via a limited company, you need to be aware that you are effectively a separate entity to your company so any money in the company’s bank account is not necessarily yours (the price you pay for paying 20% tax on all of your income instead of potentially 40% or 45%).

I appreciate that this is a bit of a complicated topic so if you need any advice with regards to your Director’s Loan Account, please let us know – it is what we are here for!