What Is a Director’s Loan Accounts and How Can You Use It?

When you run a limited company you can find yourself often making decisions about how and when you extract money from the business. One option available to directors is to use what's called a Director’s Loan Account (DLA), but it's important to understand how it works, when it's appropriate and the risks involved in using it.

This post explores what a Director’s Loan Account is, how to use one correctly and what to do if it becomes overdrawn.

What Is a Director’s Loan Account?

A Director’s Loan Account is a financial arrangement where a company either lends money to or borrows money from one of its directors. It’s often used to temporarily move funds between a director and the business, outside of regular salary or dividend payments.

For this to be legal and transparent, a formal agreement should be in place before any funds are transferred. This document should set out the terms of the loan, including interest (if any), the repayment schedule and what the funds are being used for.

How Does a Director’s Loan Account Work?

Once a loan agreement is approved (typically by the company’s shareholders) it is recorded in the business’s accounting system as either an asset or a liability. If the company has lent money to the director, it’s recorded as an asset. If a director has lent money to the company, it’s a liability.

Managing a Director’s Loan Account correctly means keeping up-to-date records, ensuring timely repayments and complying with the terms of the loan. Failure to do so may result in tax charges or investigation from HMRC.

Can You Write Off a Director’s Loan?

Under certain circumstances, a company can write off a loan made to a director. However, the decision is not as simple as crossing it off the books.

Before any write-off can take place, the business must first confirm that the loan is legally unenforceable or that the business is in a strong enough financial position to absorb the loss. If that’s the case, shareholders must give formal approval for the write-off.

It’s essential that the write-off is clearly documented in the company’s accounts, along with the reasons behind it. Directors should also be aware that the written-off amount may be treated as personal income for tax purposes, which could result in additional liabilities.

Given the complexity, expert advice should always be sought before proceeding with a loan write-off, which is where our team can help. 

How to Properly Record a Director’s Loan

To maintain legal and financial transparency, it’s important to document a Director’s Loan Account accurately. Director’s Loan Accounts are categorised as related-party transactions, so care must be taken to meet legal and accounting standards.

Draft a formal loan agreement that clearly outlines all the relevant terms, including any interest payable and how the loan will be repaid. Once approved by the shareholders, the loan should be entered into the company’s accounts as either a debtor or creditor figure.

Regular reviews are important to track repayments and ensure the agreement is being followed. The existence and terms of the loan must also be disclosed in the company’s annual accounts to ensure full compliance with financial reporting requirements.

How Much Can You Borrow From Your Company?

While there’s no statutory cap on how much a director can borrow, the company must remain solvent and able to meet its financial obligations. In practice, the amount available will depend on the company’s cash reserves, profitability and ongoing cash flow.

If the business is under financial strain, lending large sums to a director may be considered reckless or even unlawful. It's also important to consider how any loan could be perceived by creditors and other stakeholders.

What Happens If a Director’s Loan Becomes Overdrawn?

If a director owes money to the company and fails to repay it on time, the loan becomes ‘overdrawn’. This can trigger several consequences, including personal tax charges for the director under Section 455 of the Corporation Tax Act, and increased scrutiny from HMRC.

Overdrawn loans also raise concerns if the company becomes insolvent, as they may be seen as detrimental to creditors. Directors in this situation should seek advice immediately to understand their options and responsibilities. The experienced team at Horizon Business Shield is here to offer advice and practical steps forward.

Can a Director’s Loan Account be Useful?

Director’s Loan Accounts can be helpful tools when used responsibly and documented correctly. However, they come with strict rules and potential risks, particularly if repayment is delayed or the account becomes overdrawn.

If you're considering setting up a Director’s Loan Account or dealing with a complicated situation involving an existing one, it's essential to get professional advice. Understanding your legal and tax obligations is the best way to avoid potential problems down the later on.

Speak to our team today for clear, confidential advice tailored to your business and its circumstances.