Director’s Loans: A Guide for UK Businesses

  • Tax Planning Accountant

    A director’s loan can refer to both money borrowed by a director from their own company and money lent by the director to the company. These loans can be a useful financial tool for business owners, providing flexibility in managing personal and company finances.

    However, to make the most of director’s loans and avoid potential pitfalls, you should have a solid understanding of their complexities and ensure compliance with UK regulations.

    In this article, we’ll explore what director’s loans are, how they work, their legal and tax implications, and best practices for managing these loans effectively.

    By the end, you’ll have a solid understanding of how director’s loans work and whether they’re the right option for your company.


    What is a Director’s Loan?

    A director’s loan is a financial transaction involving the lending or borrowing of funds between a director and their company.

    Director’s loans allow company directors to access company funds for personal use or inject personal funds into the company for various purposes. These transactions should not be classified as salary, dividends or expense reimbursements.

    Director’s loans offer a variety of benefits including:

    • Financial flexibility: Director’s loans can help address short-term cash flow needs or allow directors to seize business opportunities without relying on external financing.
    • Timing: In situations where immediate access to funds is needed – such as covering urgent business expenses or capitalising on time-sensitive investments – director’s loans can be a quick and convenient solution.
    • Cost-effective financing: Compared to traditional borrowing options like bank loans or overdrafts, director’s loans can be a more cost-effective financing alternative and potentially help businesses save on interest expenses and fees.

    However, there are a couple of important things to keep in mind. Both the company and the director must be aware of the tax implications associated with the director’s loans, including potential penalty fees if the loan is not repaid within a specific period.

    Accurate record-keeping and compliance with company laws in the UK are also crucial to avoid penalties and ensure transparency in financial reporting.


    What is a Director’s Loan Account?

    A Director’s Loan Account (DLA) – sometimes called a Directors Current Account (DCA) – is a financial ledger used to record any transactions between a company and its directors that fall outside of regular salaries, expenses or dividends.

    Responsibility for managing the DLA typically rests with the company’s financial controller, accountant or bookkeeper. They ensure accurate recording of director’s loans, including any credit or debit transactions, loan repayments, or paid interest.

    They should also reconcile the DLA balance with the company’s financial statements and ensure compliance with legal and regulatory requirements.


    How does a Director’s Loan work?

    • Borrowing from the Company

    Director’s loans allow directors to withdraw funds from the company for personal use, such as covering unexpected expenses or making investments.

    It’s a good idea to seek advice from professional accountants at this point to assess the director’s financial needs, the company’s financial accounts, and seek advice about any potential tax implications.

    The accountants should then help draft a detailed loan agreement specifying the loan amount, repayment terms and any interest rates. This agreement must be reviewed and approved by the rest of the company’s directors before the loan can be made.

    Finally, the transaction is recorded in the Director’s Loan Account as a debit balance.

    • Lending to the Company

    If the company needs funds to support its operations or finance specific projects, directors can choose to inject their personal funds into the company.

    The process is similar to borrowing from a company: the director should assess the company’s finances with their accountant’s help and create a written loan agreement with the relevant terms and conditions.

    Following approval from the board of directors, the loan is recorded in the DLA as a credit transaction.

    When does a Director’s Loan have to be repaid?

    A director’s loan must be repaid according to the repayment terms in the director’s loan agreement. These terms are agreed before the loan is made and should be documented in writing to provide clarity and protection for both parties. They must also comply with legal requirements, including those outlined in the Companies Act 2006.

    Terms included in the repayment agreement may include:

    • Repayment schedules: The timeline for repayment, including specific dates, intervals, or conditions under which the director’s loan must be repaid.
    • Interest rates: If applicable, repayment terms should include the agreed-upon interest rate at which the director’s loan accrues interest, as well as any conditions regarding interest payments.
    • Flexibility: Parties may also choose to include a degree of flexibility in the director’s loan agreement, such as adjusting the repayment schedule due to financial difficulties or changes in the director’s personal circumstances.


    Laws and Regulations for Director’s Loans

    In the UK, director’s loans are subject to specific regulations outlined in the Companies Act 2006. These rules are designed to ensure transparency, fairness and accountability in any financial transactions between directors and their companies.

    Under this law, companies are required to maintain accurate records of all director’s loan transactions. This includes documenting the amount borrowed or lent, the terms of the loan, and any interest charged. Additionally, directors must obtain approval from all shareholders for certain types of transactions, such as loans exceeding certain limits.

    The Companies Act 2006 also prohibits certain transactions related to director’s loans, such as:

    • Providing a loan to a director for purchasing shares in the company.
    • Using company funds to provide security for a loan taken out by a director.
    • Writing off a director’s loan without approval from the shareholders.

    Failure to comply with legal requirements regarding director’s loans can result in serious consequences. Directors may face personal liability, fines or even disqualification from acting as company directors.

    Similarly, companies can face financial penalties, reputational damage, or even legal action against the company or its directors.

    That’s why it’s important to work with experienced accountants, business consultants and legal professionals to ensure your director’s loans are managed accurately and correctly.


    Tax Implications of Director’s Loans

    Companies are required to disclose details of director’s loans in their annual financial statements and company tax returns. This includes information on the amount of the loan, any interest charged, and the repayment terms.

    Director’s loans can have significant tax implications for both the company and the director involved. In general, if a director’s loan is not repaid within nine months and one day after the end of the company’s accounting period, the company may be subject to tax charges known as Section 455 tax. This tax is levied at a rate of 32.5% on the outstanding balance of the loan.

    For the director, there are potential tax consequences if the company charges interest on the loan at a rate below the official rate set by HMRC – currently 2.25%. In such cases, the director may be liable to pay tax on the difference between the official rate and the actual rate charged.

    If a director’s loan is written off or released, either wholly or partly, there may be tax implications for both the company and the director. The amount written off could be treated as additional income for the director – making it subject to income tax – while the company may be able to claim relief for the amount written off as a deductible expense.

    It’s essential to seek professional advice from specialist tax accountants to mitigate any potential tax liabilities and ensure your director’s loans are compliant with UK law.


    Work with Professional Accountants

    When it comes to managing director’s loans, partnering with expert accountants can make all the difference. At Mollan & Co, we offer a range of specialised accounting services tailored to meet the unique needs of directors and companies in the UK.

    We have over 40 years of experience in the industry and understand that every company’s situation is unique. Our personalised accounting solutions will give you the confidence and support you need to effectively manage your director’s loans, protect against risks, and achieve your company’s financial goals.

    Contact us today to learn more about how we can help.

    Author Profile
    Owner and Managing Director at Mollan & Co

    I'm the owner and Managing Director of Mollan & Co Accountants. I'm a skilled and efficient accountant with more than 20 years of experience in the industry.

    I developed valuable skills in commercialisation through my work in the science and technology department at the Scottish University. Then, in 2002, I formed my own internet-based marketing company, producing and distributing 360° virtual reality tours for the Scottish tourism sector.

    I now use my commercial skills, expert tax knowledge and first-hand experience to help other businesses grow and flourish through strong accounting practice.

    Our success at Mollan & Co is directly related to the success of our clients.