If you’re the owner of a limited company then you may be familiar with the concept of a directors loan, the name is a pretty good description of what it is but I wanted to share a bit more information about the important role it plays in tax planning.

Often when a company starts up the owner has to invest money to get it going, this could be for a multitude of things ranging from incorporation costs and equipment all the way through to supporting the day to day running costs until the business makes a profit.

Unless in the unusual event that additional shares are issued to compensate the business owner for these expenses then the investment would essentially be treated as a loan from the owner to their company.

Later on when the company starts making a profit and paying a salary or dividends instead of making actual bank payments these can also be adjusted in the director’s loan to show an enhanced debt by the company to the owner.

If you’re thinking what’s the point then imagine a scenario where you want to use up your tax allowances for salary but don’t want to take the cash out of your business, this might be at the year-end if you want your cash balance to look healthy or it could even be to save up for future investment.

If anything else using a directors loan in this way is a great convenience, after all not having to produce a payslip or dividend voucher and board meeting minutes every time a business owner takes money out of their company can save a lot of time with everything taken care of in one go in March.

That said director’s loans have never been as simple as they sound, one of the danger areas for business owners can be when they overdraw their director’s loan account and they owe the company money.

If the directors loan is overdrawn 9 months after the year end, then there are additional taxes to pay plus interest, also if the loan was more than £10k overdrawn at any point in the year then it has to be treated as an employee benefit with tax paid on it.

To effectively use a director’s loan a real-time picture of company profits is needed so that dividends can be issued at the right time to avoid the account becoming too far overdrawn and incurring tax charges, decent accounting software like Xero or other cloud based applications can be a valuable tool in achieving this.

This is part of a series of articles that I’m writing about the importance of managing director’s loans effectively in a company for tax reasons, if you would like to discuss anything I’ve mentioned then please contact us at Northants Accounting (Accountants based in Northampton).