When you choose to set up a limited company, it is a separate legal entity to you as an individual. This is one of the benefits of running a business in this way, as it offers you limited liability and you only risk what you put into the business. Therefore, the money in your limited company bank account does not belong to you.
This is why a director’s loan account is set up that summarises the transactions between a company director and the company. Any monies introduced to the company from the director’s personal funds is therefore a loan to the company and can be repaid to the director at a later date. Similarly, expenses paid personally by the director which are used solely for business are also therefore repayable to the director.
Your Director’s Loan Account needs to contain evidence of all transactions which are personal and also any expenses that were paid directly by the director i.e through a personal account, as well as money that has been loaned to the business by director’s. This account must be accurate and reviewed to ensure it’ll stand up to scrutiny by HMRC.
Business expenses are any expenses that are incurred wholly, exclusively and necessarily in the performance of the duties of the business. Anything that fails this test is, therefore, a personal expense and must be paid through your director’s loan account.
This is a risky area of running your own limited company, and for this reason, HMRC will keep your Director’s Loan Account under review through the company’s annual accounts to ensure rules and guidelines are being followed.
An example of this, would be if Joe Bloggs Ltd (building firm) director Joe Bloggs paid for building materials of £5,000 through his own personal bank account, which were then used wholly for the business purposes. This transaction would be processed through the director’s loan account and the director’s loan account would show a balance of £5,000, meaning that money is owed to Joe Bloggs the director.
Recent ruling on accuracy of director’s loan accounts:
Director’s Loan Accounts are an important aspect in limited company accounts and require great care and accurate reporting. HMRC require the Director’s Loan to show dates, amounts and descriptions of each transaction. In a recent ruling from the case ‘Matharu Delivery Service Ltd v Revenue and Customs  UKFTT 553 (TC)’, the company in question provided HMRC with a copy of their director’s loan account, which was not in itemised with descriptions or chronologically ordered and the company was issued with penalties for failure to comply.