Director's loan account explained: tax, lender views and funding the company

This guide is for directors of owner-managed limited companies who want to understand what their accountant means by "your DLA is overdrawn", or who have lent their own money to the business and are wondering how that affects future borrowing. Smart Funding Solutions is a broker arranging company finance from around £10,000 to £500,000+, with larger facilities available in suitable cases, so we focus on how the account looks to lenders; your accountant should advise on the tax. More explainers are in our business finance guides.

01What a director's loan account records

A limited company is a separate legal person, so its money is not the director's money. Every time cash moves between the two outside a formal payment route, it goes through the director's loan account. Common entries include:

• personal bills paid from the company bank account
• cash drawn "on account" of dividends that have not yet been declared
• savings the director pays into the company to cover a shortfall
• business costs paid personally by the director and not yet reimbursed

The balance can be in credit, where the company owes the director, or overdrawn, where the director owes the company. In small companies, the DLA often swings between the two through the year, and the position at the balance sheet date is what appears in the accounts. GOV.UK's director's loans guidance sets out the basic rules.

02When the director owes the company

An overdrawn DLA is common and not unlawful, but it carries tax and legal consequences.

Section 455 tax

If a close company has lent money to a director who is also a shareholder, and the loan is not repaid within nine months and one day of the end of the accounting period, the company must pay an additional corporation tax charge under section 455. The rate is linked to the higher dividend tax rate, so check GOV.UK for the current figure. The charge is reclaimable once the loan is repaid, released or written off, but the refund is not immediate, so cash is tied up with HMRC in the meantime. See if you owe your company money for the detail.

Benefit in kind

If the loan is more than £10,000 at any point in the tax year and the director pays less than HMRC's official rate of interest, the difference is usually a taxable benefit reported on a P11D, with employer's National Insurance on top.

Repaying and re-borrowing

Repaying a large balance just before the deadline and drawing it out again shortly afterwards does not work. Anti-avoidance rules match repayments of £5,000 or more with new borrowing taken in the following 30 days, and look at arrangements to re-borrow larger sums, so the section 455 charge still applies. Real repayment, usually by declaring a dividend or paying a bonus through payroll, is what clears it.

Company law and insolvency

Company law generally requires shareholder approval for loans to a director above £10,000. If the company later becomes insolvent, a liquidator will treat an overdrawn DLA as a debt owed by the director and can pursue it personally. This is one of the most common ways directors of failed companies find themselves personally liable.

03When the company owes the director

A credit balance arises when a director puts their own money into the business, often in the early years or to get through a tight spell. The director can usually take it back tax-free as a repayment of capital, and the company can pay interest on it if agreed. Interest is taxable income for the director, and the company normally has to deduct income tax before paying it and report it to HMRC. GOV.UK covers this under if you lend your company money.

A credit DLA is effectively unsecured debt owed to the director. If the company fails, the director ranks alongside other unsecured creditors unless they took security, which few do.

Company law generally requires shareholder approval for loans to a director above £10,000.

04How lenders assess the director's loan account

Every underwriter looking at an owner-managed company checks the DLA in the balance sheet notes, and it can shape the outcome of an application.

• Overdrawn balances: many lenders deduct an overdrawn DLA from net worth, because money owed by a director is unlikely to be collected while the business trades. A company with modest net assets can look insolvent on this adjusted basis.
• Pattern of drawings: a DLA that grows year after year suggests the directors are taking more than the business earns, which raises questions about affordability.
• Unpaid section 455: an outstanding charge sits in the tax creditor figure and competes with any new lender for cash.
• Credit balances as support: money lent by directors shows commitment, and lenders may treat it as quasi-capital when judging gearing.
• Postponement: in return, a lender may ask the director to sign a letter or deed agreeing not to withdraw the balance, or to rank it behind the lender, while the facility is outstanding.
• Use of the new money: lenders are reluctant to fund repayment of a director's loan, because the money leaves the business instead of generating income.

Our guide to how lenders assess applications covers how these adjustments feed into the overall decision.

05Funding decisions that involve the DLA

Replacing director money with a facility

Directors who have lent heavily to their company sometimes want a business loan so they can take their money back. It is possible, but lenders will see it as extracting capital rather than investing it. It is easier to justify where the director funded a specific asset or cost that a lender would normally have financed, such as equipment, in which case asset refinancing can release cash against that equipment.

Borrowing to clear an overdrawn DLA

Borrowing through the company to clear a director's debt to the company is circular: the money simply moves from one side of the balance sheet to the other and the section 455 problem does not go away. The usual fixes are dividends, where there are distributable reserves, or salary through payroll.

Covering a tax bill

When cash is short at the year end, directors sometimes draw more to pay personal tax, which inflates the DLA. Spreading the company's own corporation tax or the director's self-assessment bill with a tax loan keeps the loan account cleaner.

Growth

If directors keep topping up the company to fund growth, a proper facility such as an unsecured business loan or working capital loan may be the better long-term answer, leaving personal savings as a genuine reserve.

06Documents lenders ask for

07How we can help

1. We look at your accounts, including the DLA, the way an underwriter will.
2. We flag anything that needs explaining or tidying with your accountant before an application.
3. We approach lenders on our panel that suit your figures and purpose.
4. Lenders decide; you choose whether to proceed. It is free to enquire; any broker fee is disclosed separately before you proceed.