Rachel Lai – Insolvency Specialist
There are times when a company may need a quick cash injection and directors’ loans can be a valuable way for owner managers to lend money to the business, to be repaid in the future. However, directors should be cautious about borrowing company funds for personal gain, as they are at risk of difficulties if the business becomes insolvent.
Sourcing funds for the account
A directors’ loan account records money lent to, or borrowed from, the company by its directors which isn’t a business cost, such as salary or expense payments, or a dividend to a shareholder.
For instance, if the organisation is struggling to afford an important business expense such as a piece of equipment, the director might deem it appropriate to fund the asset personally, to boost business performance.
On the other hand, a director may decide to take out funds from the company via a loan if they are dealing with personal cash-flow difficulties. A common reason is to make mortgage payments or otherwise cover living expenses for the director and their family.
An individual’s personal finances unavoidably go through ups and downs, just like a company’s cash position, and this might drive a director to borrow funds from the business. Whilst this is understandable, directors need to be conscious that, like with a commercial loan, the debt remains repayable.
If the business then becomes insolvent and there is a balance payable to the company on the directors’ loan account, the amount can be chased by an insolvency practitioner against the director personally.
Receiving professional advice is also vital. A loan made to a shareholder which is outstanding nine months after the company’s year end could leave the company liable for Corporation Tax at a rate of 33.75 per cent on the loan. Moreover, there could be effects on the individual’s personal tax position. Understanding these rules around borrowing cash from the business can help to avoid any nasty surprises at a later date.
Carefully record transactions
When using directors’ loan accounts, a thorough approach to recording transactions is important. Regular reconciliations will help directors to maximise the benefits of this valued cash-flow tool, whilst also keeping in control of both the company’s and their own financial positions.