If your business is set up as a Company rather than a Sole Trade or Partnership, it is important to remember that the Company is a separate legal entity. It is “Corporate” from the Latin “corpus” meaning body and has its own legal existence. It can own property, be sued, or sue others through the Courts and pay its own type of tax (Corporation tax). To “incorporate” a business means to give it an independent legal standing as a Company.
An individual can have three types of relationships with a Company.
They can be a:
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- SHAREHOLDER – they own all or part of a Company
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- DIRECTOR – a person legally appointed to direct and safeguard a company’s affairs
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- EMPLOYEE – a person with an employment contract with the company
A person can wear one, two or all three hats and in small companies the “owner” is usually all three.
A person is entitled to be paid by the company in different ways depending on the hats they wear as follows:
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- Shareholder – Can be paid a share of the profits by means of a Dividend
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- Director – Can receive remuneration for acting as a director, normally via PAYE
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- Employee – Can receive a salary for work performed, always via PAYE.
It is probably clear by now that money in a company’s bank account, unlike a sole trade, belongs to the company, not the individual. If therefore money is taken out of a company other than by the above methods, it’s a loan. Therefore it will eventually have to be repaid to the company. The Directors Loan Account (DLA), sometimes called the Directors Current Account (DCA), is the interface between the human and the company. Any transactions of a personal nature are recorded in the Company’s books in an account with that name.
Some typical transactions in this account would be:
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- Expenses paid by the company which are personal rather than business. For example in a restaurant, the value of food or beverages removed for personal use, or the cost of travel for a partner on a business trip.
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- Money taken from the business to cover an emergency personal expense.
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- Money taken over and above the Director’s PAYE salary with the intention of repaying this out of profits (via a dividend) later. This is the most common entry in a small business DLA because, unlike a PAYE salary, there is no National Insurance charge on dividends. This can therefore be a more tax efficient means of remuneration as opposed to paying a higher salary. This however is not always the case and depends on may factors. Your accountant will advise HMRC will frown on monthly drawings which are salary in disguise.
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- If a director pays the company an amount of money as a temporary loan (as opposed to an investment in shares) then this will appear as a credit in the DLA.
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- When a dividend is declared at the end of a year when the profits are known, this is usually credited to the DLA. The director can draw on any DLA credit balance without any further tax, funds permitting
Cont…
There is a tax law called section 455 of the 2010 Corporation Tax act. This which charges 33.75% tax on any DLA balances not repaid within 9 months of the company’s year-end. This s455 tax is refundable when the loan is repaid. If the directors loan increases the following year, only the increase will be subject to the 33.75% charge. Any partial repayment will allow part of the s455 tax to be refunded. The rate was 32.5% up to 5.4.22.
Another tax issue to consider is that if the Director’s loan is interest free and exceeds £10,000, then HMRC will demand tax on the benefit-in-kind. Ensure that the company charges the participator a reasonable amount of interest on the DLA balance if it exceeds £10,000.
If you have any questions about a potential director’s loan, Baxterworld is always happy to help. Contact – [email protected].
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