I have a Ltd company client who I have recently taken over. The director took out a personal business loan to buy the business a few years back and at the moment, the director is taking cash out of the company to pay the monthly loan repayments in their private name.
As things stand, the loan has not been introduced into the company in the form of a directors loan. Their previous accountants have been charging the interest costs of the loan (which are in addition to the monthly repayments) to the expense account presumably through the directors loan account as the director has not been taking any additional cash out to cover the interest element, but I need to clarify the correct position regarding the monthly capital repayments that the director has been taking out of the company in cash.
Should these be charged to the directors loan account? If so, the directors loan account will be constantly reducing and in effect the director will end up owing money to the company. To balance this, should the equivalent amount be shown as a loan to the company from the director every month, therefore resulting in a zero change to the loan account?
Has this been set up correctly in the first place? Or should the whole of the loan have been introduced in the form of a directors loan, with the monthly repayments reducing it until the loan is repaid and the interest element being reimbursed to the director in the form of an expense.
Basically, what should have been done and what is the correct way to move forward with this!
This is actually what a directors loan account was intended to be used for (rather than the piggy bank that most directors seem to think it is!).
The director has loaned the company money which they have themselves loaned privately.
The company is repaying the director the loan plus interest which is acceptable treatment espechially where the interest can be linked directly to a loan rate as in the case of the private loan.
It is not the optimum way of introducing money to the company as the diretor will have a personal tax liability for the interest payments receieved from the company, however, for many who cannot get finance for the company via the company itself it is their best option.
The company is effectively paying interest to the director who pays it on but in doing it this way they are introducing an element of additional personal income which will be taxable.
The best way to classify the two elements would be repayment of capital for repayments of the loan (which would be non taxable on the director) and drawings for the interest apportionment (which would be taxable on the director).
As you correctly identify this may cause the DLA to go overdrawn. However there is nothing otherwise untoward about this financial arrangement.
HTH,
Shaun.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
I dont understand why the previous accountant didnt introduce the full value of the loan in the first place (Chartered Accountants too!), that way the directors loan account will gradually decrease back to zero (ignoring other transactions) as the business loan is fully repaid. Surely this is a better way of accounting for the loan than if the DLA is left to go overdrawn.
Lets say I dont introduce the loan at this stage and continue to charge the capital repayments to the DLA. Would you balance this off with an eqivalent value as a loan introduced, either every month or every year, to prevent the DLA becoming overdrawn? If not, isn't there a potential problem for the director benefiting from a beneficial loan from the company if the DLA becomes overdrawn?
Also, you say the interest payments received by the director are taxable in the hands of the director. However, couldn't they claim relief for interest paid on a qualifying loan?
(Extract from HMRC hs340): You may be able to claim relief for interest paid or for alternative finance payments where the loan or alternative finance arrangement is used:
to buy ordinary shares in, or lend money to, a close company in which you own more than 5% of the ordinary share capital on your own or with associates, or you own any part of the share capital and work for the greater part of your time in the management and conduct of the companys business, or that of an associated company.
