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.
Repaying the balance of a director’s loan account that’s in debit within nine months of the end of the Corporation Tax accounting period can avoid a section 455 tax charge, but other tax, reporting and insolvency consequences may still arise depending on the amount and circumstances. 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 your director’s loan account has become overdrawn and the company is a close company (most owner-managed companies are), the company tax return must show the amount owed where you are a shareholder or other participator, or an associate of one. If the company has lent to you as a shareholder or other participator, or to someone associated with you, it must also pay a section 455 tax charge on any part of the loan still outstanding nine months after the end of the accounting period in which the loan was made. The charge does not arise on any part repaid, released or written off by then, or where an exception applies, such as for loans of up to £15,000 in total to a full-time working director who does not have a material interest in the company. You should be aware that HMRC can ask about a director’s loan account if it opens an enquiry into the company tax return, normally within 12 months of the return being filed, and can look back further where tax has been under-declared, 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 in which the loan was made has finished, you have nine months to repay the loan, or for the company to release or write it off. If a qualifying loan is still outstanding at that point, the company faces a tax charge under section 455 of the Corporation Tax Act 2010, which falls due the next day, nine months and one day after the year end. This is not a penalty. It is a charge under the close-company loans-to-participators rules, and it is refundable: the company can reclaim it once the loan is repaid, released or written off, subject to the statutory conditions and timing. For loans made or benefits conferred on or after 6 April 2026 the rate is 35.75 percent. Different rates apply to earlier loans, including 33.75 percent from 6 April 2022 to 5 April 2026 and 32.5 percent from 6 April 2016 to 5 April 2022, and the rate is fixed by reference to when the loan was made rather than when it fell due.
A second charge sits alongside the section 455 tax, and it is worth keeping them apart because they are calculated on completely different amounts. Where the combined balance you owe the company goes above £10,000 at any point in the tax year, and you pay either no interest or less than HMRC’s official rate, the cheap loan is a taxable benefit in kind.
What is taxed is the benefit, not the loan. The cash equivalent is the interest that would have been payable at the official rate, less any interest you actually paid. The official rate is 3.75 per cent from 6 April 2026. So on a £50,000 interest-free balance held for a full year the benefit is in the order of £1,875, not £50,000. The benefit goes on a P11D, you pay income tax on it, and the company pays Class 1A National Insurance.
The loan is still a loan. It is still owed to the company, it is still an asset a liquidator can pursue, and the section 455 charge still applies to any balance not repaid, released or written off within nine months of the year end. Writing the loan off later is a third thing again, with its own treatment for both of you.
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 normally treat the overdrawn director’s loan account as an asset of the company and consider recovery action. How much is ultimately recoverable depends on the accounting position, any valid set-off or credits to the account, and the facts of the case. 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, the Official Receiver initially becomes liquidator, although another licensed insolvency practitioner may later be appointed to the role. 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’ — one controlled by five or fewer people with a stake in it (‘participators’, a wider group than just shareholders), or controlled by its own director-shareholders, under section 439 of the Corporation Tax Act 2010 — the company can write off a director’s loan whether or not the director is a shareholder, but the tax treatment depends on who the director is. If the director is a participator, such as a shareholder, or an associate of one, the amount written off is generally taxed on the director as if it were a dividend.
If the director is not a participator in the close company or an associate of one, the amount written off is generally taxed as employment income. It counts as the director’s taxable income for the tax year in which it is written off. 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 will look at what recovery action is appropriate, weighing the evidence, the likely recovery and the costs involved, so that creditors can be repaid in part or in full where possible. 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.
Need advice?
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.