Overdrawn Director’s Loan Account – Rules, Tax & Repayment
If a limited company is starting to fail financially then an overdrawn director’s loan account can cause serious problems for the company’s directors. In fact, overdrawn directors’ loan accounts and their implications are one of the areas we’re contacted about the most.
We have created an in-depth guide, written in plain English, to help you understand exactly what the potential problems with an overdrawn director’s loan account are and what they could mean for you.
What is an overdrawn directors’ loan account?
An overdrawn director’s loan account is simply a director’s loan that has not been repaid. It is quite common for the directors of limited companies to take money out of the business in some form other than a dividend or salary. If they do, any money they take is considered to be a loan from the company to the director, and just like any other loan, it must be repaid.
As a limited company is a separate legal entity from the director personally, any money taken out of the business is subject to scrutiny. A director’s loan account is used to record and document the transactions between the company and the director.
- If you don’t take any money out of the company (aside from salary and dividends), the director’s loan account will have a zero balance.
- If you pay personal funds into the company (perhaps to buy assets or equipment), the director’s loan account will be in credit and the company will owe you money.
- If you take money out of the company, the director’s loan account will be in debit and you will owe the company money.
Having a director’s loan account that’s in debit is not a problem, as long as the balance of the loan is repaid within nine months of the end of the accounting period. The trouble arises when a director’s loan is not repaid within nine months of the company’s year-end, or worse still, the business starts to perform poorly and becomes insolvent. That creates an overdrawn director’s loan account.
In the case of the former, the unpaid director’s loan will bring serious tax implications. In the case of the latter, having an overdrawn director’s loan account in an insolvent company can lead to severe personal liability issues.
Disclosure of an overdrawn director’s loan account
If you have a director’s loan account that has become overdrawn, your company tax return must reflect that by showing the amount owed. The company will have to pay corporation tax on any amount that has not been repaid nine months after the end of your accounting period. You should be aware that HMRC can question you about the presence of a director’s loan account at any time as part of a corporation tax compliance check, so make sure you include all entries accurately and on time.
What are the tax implications of an overdrawn director’s loan account?
If you have an overdrawn director’s loan account, then you owe the company money. Once the accounting period has finished, you have nine months to repay the loan. Fail to do so and the limited company will incur a corporation tax penalty of 32.5 percent of the loan.
If the sum involved is more than £10,000 and the loan is interest-free or is charged at less than commercial rates (realistically, most directors’ loans are interest-free), HMRC will take the view that the director has been taking money out of their company as income. As such, there will also be income tax and national insurance implications for the director and the company. HMRC will also charge the company interest on the loan until a point where the corporation tax levied on the loan or the director’s loan account is repaid.
How is an overdrawn director’s loan account treated in insolvency?
Sometimes a company will try to reduce or clear the director’s loan account by voting the balance as a bonus or dividend. However, if the company then enters an insolvent liquidation, it could set the company and the director up for a fall.
During liquidation, the liquidator’s job is to collect all the money that’s owed to the company. If the amount is significant, the liquidator will view the overdrawn director’s loan account as an asset they can pursue to increase the repayment for the company’s creditors. That’s particularly likely to be the case where the sale of company assets does not cover the cost of liquidation or provide a substantial return for the creditors.
In that instance, the liquidator will take action to recover the director’s loan, which could put pressure on the director’s personal finances. If the director does not have the funds available to repay the loan, their personal assets could also be at risk. Ultimately, legal action could be taken to recover the funds and force the director into bankruptcy.
From the company director’s point of view, the situation will potentially worsen if the company is forced into liquidation by a creditor such as a supplier or HMRC, rather than entering into liquidation voluntarily. In the case of compulsory liquidation, it will be the Official Receiver who liquidates the company. They will look more closely at the circumstances in which the overdrawn director’s loan account was created. Potentially, that could lead to accusations of wrongful trading and/or misfeasance against the director, which could lead to a ban from operating as a company director for a period of up to 15 years.
Can an overdrawn directors’ loan account be written off?
There may be instances where an overdrawn director’s loan can be reduced for legitimate reasons. For example, if business mileage has been paid for by the director personally or if assets bought for the company have been paid for with the director’s personal funds.
In certain circumstances, an overdrawn directors’ loan account can be written off completely. In a ‘close company’, defined as a limited company with fewer than five shareholders, a director’s loan can be written off if that director is also a shareholder. In that situation, the director’s loan will instead be treated as a distribution of profits.
If the director is not a shareholder in the close company, the outstanding amount will be taxed as employment income. That must be included on the director’s own tax return within the ‘additional information’ section. If you pay tax at the higher rate then the amount due can be considerable. You will also have to pay National Insurance contributions.
However, that will not necessarily be the end of the story. In a company liquidation, the liquidator has a legal duty to pursue every possible avenue to raise funds so the creditors can be repaid in part or in full. In this instance, the liquidator may pursue the director for what was in the overdrawn director’s loan account, even if the debt had previously been written off.
If your company is insolvent and you have an overdrawn director’s loan account, get in touch with our team of licensed insolvency practitioners at your first opportunity. We will provide a free and confidential consultation to help you understand your options.