Save tax by combining directors’ loan accounts

Borrowers and lenders

It’s common for a company owner manager to use their personal funds to support their company or vice versa, i.e. for the owner manager to draw on the company’s cash to meet personal spending. Such ins and outs must be recorded in the company’s records and are referred to as the directors’ loan account (DLA). If your DLA is overdrawn, i.e. you owe your company, it can result in tax charges for you and it. In this article we’re looking only at your tax position.

Taxable perk

You’ll face a tax charge under the benefit in kind rules if at any time during a tax year your DLA is overdrawn by more than £10,000, even if it’s just by £1 for a single day. The taxable amount is based on the whole overdrawn amount, not just the excess over £10,000, and is calculated by applying HMRC’s official interest rate (currently 3.75% per annum) to the average overdrawn balance for the tax year.

Joint DLAs - overall credit balance

Turning to the question at the start of this article, there’s sometimes a good argument for amalgamating your and your spouse’s DLAs to avoid or reduce a tax charge.

Example. Bob injected £20,000 of his own cash into his company while Sarah, his spouse, has used its money and now owes it £15,000. Putting the transactions through a single joint DLA means it would not be overdrawn and so a tax charge would be avoided.

While it’s difficult for HMRC to check, strictly, DLAs that are recorded separately day-to-day cannot be aggregated, say, at the end of a tax year for the purpose of reducing the tax charge.

Note. There’s an exception to the trap where an owner manager has more than one DLA with their company. HMRC allows an election to treat all DLAs as one if they are for the same person.

Joint DLAs - overall debit balance

An overdrawn DLA that’s for more than one owner manager can work against you for tax purposes.

Example. Janet and John have a shared DLA. It is overdrawn by £11,000, of which £8,000 is attributable to John’s drawings and the balance to Janet. While neither exceeds the £10,000 limit, HMRC follows general law by viewing the debt as joint and several. The effect of that is both Janet and John are treated as liable for the whole £11,000. As that exceeds the £10,000 limit the benefit in kind tax is triggered. Had they run separate DLAs the limit would not have been breached and so no tax charge would apply.

Good record keeping and planning are key to avoiding or minimising the benefit in kind tax for overdrawn DLAs. You can amalgamate or separate DLAs as and when it suits you to avoid the £10,000 limit being exceeded.