Many owner-managed companies use a Director’s Loan Account (DLA) to record money moving between the director and the company.
Most of the time, the account shows the director owing money to the company. But sometimes the opposite happens.
If a director has put more money into the company than they’ve taken out, the account will be in credit. When that happens, an important question arises:
Can the director charge interest on the money owed to them?
The short answer is yes — but there are a few tax and practical considerations to keep in mind.
What Is a Credit Director’s Loan Account?
A credit balance on a DLA means the company owes money to the director.
This can happen in several ways, including:
- A director lending money to the company
- Unpaid dividends
- Undrawn salary or remuneration
- Expenses personally paid by the director on behalf of the company
In these situations, the director may decide to charge interest on the outstanding balance.
How Much Interest Can Be Charged?
There’s no fixed limit on the interest rate a director can charge.
However, the rate should be commercially reasonable. If the rate is excessive, HMRC may question whether the loan was made “wholly and exclusively” for business purposes.
A sensible benchmark is the rate a company might pay a bank for unsecured borrowing.
At the moment, average rates are around 6.95% per year, although they can range from roughly 6% to 15% depending on circumstances.
What Are the Tax Implications for the Company?
Interest paid on a director’s loan is usually treated as a non-trading loan relationship.
If the loan was used for business purposes, the interest may normally be deductible for corporation tax.
However, there are a couple of things to watch for.
First, the company must ensure the loan is genuine and charged at a commercial rate, otherwise HMRC may treat the payment as a distribution instead of interest.
Second, for close companies, the interest must be paid within 12 months of the end of the accounting period in which it accrued to qualify for corporation tax relief.
Most owner-managed companies fall into the “close company” category, which broadly means the company is controlled by:
- Five or fewer participators, or
- Any number of participators who are also directors
Does the Company Have to Deduct Tax?
Yes. When a company pays interest to an individual, it must normally withhold income tax at the basic rate.
The company must:
- Deduct tax from the interest payment
- Submit a quarterly CT61 return to HMRC
- Pay the tax deducted to HMRC
- Provide the director with a certificate showing the tax withheld
Failing to follow this process properly can result in penalties or interest charges.
What Are the Tax Implications for the Director?
For the director, the interest received is treated as savings income.
Depending on the director’s overall income, some or all of the interest may fall within the Personal Savings Allowance.
Currently this allowance is:
- £1,000 for basic rate taxpayers
- £500 for higher rate taxpayers
- £0 for additional rate taxpayers
If the interest falls within the allowance, it may effectively be tax-free, although the company must still apply the withholding tax rules.
If the director’s income is higher, additional tax may be payable through Self Assessment.
What About Company Law?
Before charging interest, the company should check its articles of association.
Most companies using the Model Articles are permitted to pay interest on a director’s loan.
However, the terms should always be properly documented in a loan agreement. This should include:
- The interest rate
- The repayment terms
- How interest will be calculated
Why Might Directors Charge Interest?
One advantage of charging interest is that interest can be paid even if the company has no distributable profits.
Dividends, on the other hand, can only be paid from available profits.
For some directors, charging interest on a credit DLA can therefore provide a way to extract funds from the company when dividends are not available.
Because DLAs often move up and down during the year, it’s also important to clearly agree how interest will be calculated — for example, using daily or monthly balances.
Final Thoughts
Charging interest on a credit Director’s Loan Account can be perfectly legitimate and sometimes tax-efficient.
However, the interest rate, documentation and tax reporting requirements all need to be handled correctly.
Taking advice before implementing this strategy can help ensure everything is structured properly.
Need Advice on Director’s Loan Accounts?
If you run a limited company and want to understand the most tax-efficient way to manage your Director’s Loan Account, we’d be happy to help.
At Jon Davies Accountants, we work with business owners across the UK to help them manage company finances and extract profits efficiently.
Get in touch with Jon or the team today to discuss your situation or ask any questions about director loans.
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