Overdrawn loan accounts and S455
Posted on 24th September 2020
Most sole traders or freelancers should never have problems when using and spending money that you've earned via your business, since it legally belongs to you personally. However, if you're a director and shareholder of a limited company, things are a little different - and quite a bit more complicated. Company money does not technically belong to you as it is the company's - and the company is a separate legal entity to you - but you do have access to it, and here is where meticulous record-keeping becomes an essential part of running a business.
Any withdrawal or transaction that cannot be justified as a company expense will end up on your director's loan account - or DLA. The other alternative to this is to declare the money taken as a bonus, which might turn out to be quite costly for the company as any bonus is normally taxable.
Directors’ loan accounts are accounts that shareholders and directors set up for withdrawing money from the company funds. Indeed, as a director, you will be able to complete some transfers if these relate to paying expenses, wages, and supplies, or if it's money that you (personally) have loaned the company and therefore belongs to you.
HMRC requires you to set up a DLA for withdrawing money that doesn’t belong to the two categories seen above. So, if you need to use the company money for any other reason, these transactions must be recorded in a DLA.
At the end of the financial year, you will need to take these recordings into account. So, you can find out whether you owe money to the company or the company owes money to you. This will depend on the transactions that you have completed in the past year and on your activity.
In the company’s records, your DLA, depending on its balance, should be recorded as a liability or as an asset.
What are overdrawn loan accounts?
As mentioned already, any withdrawal or money transaction that cannot be justified as a company expense will end up on your DLA, unless you declare it as a bonus (which can become quite expensive thanks to the tax implications a bonus might incur). If your DLA is in credit, you can take money from it without having to worry about tax implications or reporting to HMRC.
If not, you will end up with an overdrawn loan account. In this case, there are some consequences, such as the S455 and benefit-in-kind. So, if your account remains in debit or overdrawn at the end of the financial year, the company might need to pay the S455 - a holding tax payable only if the loan is not cleared or back to positive within nine months of the end of the financial year.
If it is not cleared, the company will be paying 32.5% S455 tax on the balance in the DLA. The same regulation is valid for directors and shareholders alike.
If your balance is not cleared in time or you owe your company over £10,000 (interest-free), then the loan becomes a benefit-in-kind. A company’s benefits-in-kind must be recorded, as part of the P11D. Indeed, such a loan can impact on personal and company tax rates. Furthermore, the process of going through a benefit-in-kind might make it much more complicated for a director to clear its account, as the amount becomes taxable.
The importance of meticulous record keeping
Record keeping becomes paramount when you've opened a director’s loan account, and it's essential to know whether you can be considered an asset or a liability for the company. Furthermore, keeping track of all transactions can be the key to have a healthy account that is always in credit. In an ideal world, an accountant would do this for you, but some directors choose to handle this part of running their business themselves.
It's worth noting that HMRC regularly checks overdrawn DLA accounts, and if they start considering the money you borrow as a salary rather than a loan, you might have to start paying significant taxes on this type of income. Aside from normal taxes, HMRC might also start applying income tax and National Insurance on the sum of money you have taken as a loan.
Next steps
It is essential to keep an eye on what is happening on your DLA and monitor your withdrawals closely to ensure you're keeping track of your transactions and avoiding going over the £10,000 threshold. If you'd like us to help you get your finances in order for the rest of the year and 2021, feel free to get in touch with us today for a no-obligation chat.
Written by
Nicola J Sorrell -
Effective Accounting
Founder | Xero Champion | IR35 Expert
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