Contents
- What are Director’s Loan Accounts?
- Reasons Why You Need to Deal with and Overdrawn Account
- Steps to Take When Your Director’s Loan Account is Overdrawn
- Summary
- FAQs
Introduction
For many small business owners the first time they hear about a director’s loan account is when they hear the dreaded words from their accountant that they owe their company money because they are overdrawn.
This is usually followed by the disbelief that an entity they own like their own company can also be their creditor and hold them in debt.
But sadly overdrawn DL accounts can be the case for many directors, either caused by a lack of understanding of company accounting, or done deliberately due to necessity, or even as part of a tax planning strategy.
Key Takeaways
- An overdrawn director’s loan account occurs when personal withdrawals exceed contributions or amounts issued.
- Without a strategy in place to deal with the issue, there can be significant personal risk and tax bills for the director.
- An understanding of the transactions that increase and also lower a director’s debt to their company is essential for all company owners.
To ensure you don’t leave any tax savings on the table you should also read my article on Using Holding Companies to Save Tax and my Ultimate Guide to Tax Deductible Expenses.
What are Director’s Loan Accounts?
A director’s loan account is a running total of the balance of money owed between a company and one of its directors. From the perspective of a company this can have a credit balance meaning that the company owes the director money and it can have a debit balance if the company is owed money.
How does a Director’s Loan Account become Overdrawn?
An overdrawn director’s loan account usually happens for one of two reasons.
Firstly it could be when you take more money out of the business than it can afford to pay you. It is often the case that for overdrawn directors accounts this scenario goes hand in hand with cashflow issues and the business facing challenges in paying the company’s creditors.
Secondly a directors loan account can be used as part of a deliberate tax planning strategy, where the business is both cash rich and profitable.
In this type of scenario it is usually desirable to shift the issue of dividends and salaries into another tax year to benefit from better rates, but the director could keep withdrawing cash to ensure their lifestyle isn’t impacted.
Transactions that cause your company to owe you money
- Issue of Salaries
- Issue of Dividends
- Introducing start up funds or ongoing loans
- Expense claims that weren’t reimbursed (mileage, use of home etc…)
- Introducing personal assets into the company
Transactions that cause you to owe your company money
- Withdrawal of money from the company bank account
- Company paying for personal expenses
- Transferring company assets into your personal name
Whether the director’s loan account is overdrawn or not will depend on the balance of the above factors.
When looking at the DL account it is helpful to consider that you receiving a salary or dividend from the company is actually two transactions, the first is the issue of the salary and the second is the withdrawal of the funds.
It may seem unnecessarily complicated to look at it that way, but there are many instances where dividends and salary may be issues without drawing out the money.
This is particularly prevalent in situations where you want to lock in preferential tax rates, but leave money in the business to support cashflows.
Joint Directors Loan Accounts
In situations where you have spouses running a business together who are both directors, it is possible to aggregate the director’s loan account and have a joint balance. This can be really useful in situations where money is being transferred to and from join bank accounts and can reduce the admin burden on the family.
Reasons Why You Need to Deal with an Overdrawn Director’s Loan Account
Assuming that the overdrawn position was accidental, it can be tempting to ignore it and just put it down to an accounting issue that doesn’t really have any commercial relevance to you or the business. But I would like to address a few reasons why this isn’t a good idea:
1. Section 455 Tax Charge
In an ideal world it would be possible just to loan yourself money from your company and never have to pay it back, this would be a great way to not pay any taxes on receiving salaries or dividends. In fact there have been many failed tax avoidance schemes set up in the past using this concept.
The real reason you can’t just loan yourself money without paying any tax is because of the S455 tax charge, which taxes overdrawn directors loan accounts at a rate of 33.75% of any amount that hasn’t been paid back within nine months of your company’s financial year end.
Whilst the S455 tax charge may sound like a tax, it is actually more accurate to consider it as a deposit because, if or when you do pay the overdrawn directors loan back, HMRC will refund you the tax you paid on it.
2. Personal Income Tax and National Insurance Contributions
If a director’s loan account becomes overdrawn and the balance goes beyond £10,000, it can have implications for both personal income tax and employers class 1A national insurance contributions. This is because the overdrawn account is treated as an interest free loan to an employee which would need to be declared as an employee benefit and taxed as such.
For our clients we usually charge a commercial rate of interest on the loan, which gets added to the outstanding balance and it means that our client isn’t receiving a tax free benefit. This is usually relieved later on through the issue of dividends.
The combination of corporation tax and dividends tends to be more tax efficient than the company having to pay class 1A NIC’s and the director paying income tax on the interest amount, but this isn’t always the case so bespoke advice is needed.
3. Increased Personal Risk
One of the main reasons to be proactive with an overdrawn director’s loan is due to the personal risk it causes.
If you owe your company money then that debt for the company is an asset that can be seized by it’s creditors in the event of an insolvency, which means that you could end up owing the money to someone else if it was sold on or having the debt called in.
Steps to Take When Your Director’s Loan Account is Overdrawn
It’s easy to say that the solution to an overdrawn director’s loan account is to stop taking money out of your business, but this isn’t always practical as it is likely you need a certain level of funding for your personal lifestyle.
It is however worth doing a personal budget so you do understand the exact amount you need from the business every month and then working with your accountant to ensure the salary and dividends being issued support that.
There are times when the overdrawn director’s loan is part of a deliberate tax planning strategy, in which case the best way forward is to stick to the original plan.
To get an in depth understanding on how to pay yourself tax efficiently, check our our recent article on How to get Money out of a Limited Company Without Paying Tax
Bed and Breakfasting
Bed and breakfasting is a strategy that some directors employ to manage their overdrawn directors loan accounts. This involves temporarily repaying the overdrawn amount just before the company’s financial year end, only to withdraw the same or a similar amount shortly after.
While this may seem like a clever way to avoid the S455 tax charge, HMRC has implemented rules to counteract this practice.
The 30-day rule stipulates that if a repayment is followed by a similar withdrawal within 30 days, the repayment is ignored for tax purposes. Therefore, careful planning is needed when using this strategy and it should only be used as a temporary measure as it just kicks the can down the road.
1. Repaying the Loan
It might sound like a pretty obvious solution, but you would be amazed at how many director’s chose to repay their outstanding loan balances in cash when you make them aware of the extent of taxes involved.
This is especially appealing in situations where they have taken money out and put it in a savings account because they didn’t understand that the interest they were earning wouldn’t compensate them for the S455 tax they’d have to pay.
2. Declaring Dividends
Assuming your company has the cumulative profits to allow it, then declaring dividends is a good way to reduced the amount you owe the company. For the dividend to count you will need to have a board meeting and then create the relevant vouchers and minutes.
There should be some thought that goes into the timing of any dividends to maximise the allowances and tax bands in a particular tax year, just a few days either way can make a large difference and extra care should be taken to avoid losing your personal allowance if it can be helped.
Dealing with a Director’s Loan if You’re Insolvent
On the part regarding dividends, it is important for me to mention that as a director you have certain responsibilities when it comes to the welfare of your creditors and shareholders.
Whilst a set of accounts might show a profit, it is important to take a real time view on your performance, including the factoring in of any liabilities that are likely to arise so you aren’t accused of malfeasance later on.
3. Declaring Salary
In the event there aren’t cumulative profits available to declare as a dividend then an alternative is to issue a salary. This can be a good option if you feel that the business is only temporarily insolvent and is likely to return to profitability later.
It may also be your last resort if your business enters liquidation, but then you will need to factor in that there will be PAYE taxes due from you as well as the company.
With that in mind I would argue that it is still preferable paying tax on the salary to HMRC, compared to having the entire loan called back in if the company enters liquidation.
To ensure that you’re not accused of misconduct in the event of a winding up, you should ensure that any actions you take are commercially reasonable and have officially documented.
4. Claiming Expenses
In the course of business it is likely you will incur expenses that you pay for personally. In the event that your company doesn’t reimburse you for these, then provided you logged them into your accounting system they will then reduce the amount you owe your business via your director’s loan account.
These expenses could be subsistence related, home office costs, travel or even equipment you purchased.
5. Redundancy
In the event you have a contract of employment with your company, then it is also possible to claim a redundancy payment in the event you exit.
The current tax free amount you could pay yourself is £30,000, however in order to avoid any claims of wrongdoing you would need to insure that the contract had been in place before your business got into any financial difficulty and it was reasonable based on your length of service and position.
6. Writing Off a Directors Loan
It is also possible for a company to write off an overdrawn directors loan account in which case the write off will be taxed as dividend income for the director, with the added requirement to pay employees NIC’s on it.
From the companies point of view, there isn’t any corporation tax relief on the write off of the loan amount, but there would be on any employers NIC’s paid.
Due to the double taxation as dividends are classified as salary for NIC purposes, the write off option is the least attractive of all the ways to repay the loan.
To compound this, it is also possible that an insolvency practitioner or Official Receiver will set it aside and continue pursuing you, if it happened within six years prior to the winding up.
7. Directors Loan on Liquidation
There are often times where a director can have an overdrawn director’s loan account at the point of winding up a company. I’ve outlined the various scenarios below, with the corresponding treatment.
1. Strike-off
This is the easiest way to close down a company and requires the submission of a DS01 form, providing the company has less than £25k in assets and no creditors or potential creditors.
In the event these criteria are met and the overdrawn DL position is less than £25k, it is possible to do a “distribution in situ” whereby the balance is considered repaid in lieu of you not taking a capital distribution of the assets from the business.
Potentially this means that you are released from your directors loan with the benefit of only having to pay for the capital gain at the Business Asset Disposal Relief Rate (BADR) of 14% from April 2025.
14% is still more than a basic rate dividend so you should attempt to utilise that first, but better than a higher rate dividend.
2. MVL
A Members Voluntary Liquidation is a similar situation to the above, but used in instances where the assets of the business are greater than £25k or there are creditors that can’t be satisfied. In this scenario you would have a self appointed liquidator to wind the company down.
It is really important that you understand that the insolvency practitioner works for the creditors, even in instances you were the person who appointed them so you must be extra careful that there are enough assets within the company to meet all you obligations.
Otherwise the IP can pursue you personally for any outstanding debts to the company and attempt to recover any balances on your directors loan account.
3. CVL
A Creditors Voluntary Liquidation is identical to an MVL except it is usually common in a case of an insolvent liquidation, whereby you don’t have enough assets in the business to pay your debts.
In this case the Insolvency Practitioner or even Official receiver in cases where the government is involved will have been appointed by a creditor of your company.
It is likely in this case that you will have to agree some form of payment plan to personally repay the overdrawn loan amount.
Summary
This article provides you with an in-depth exploration of managing an overdrawn director’s loan account for your limited company. It explains that such accounts arise when your personal withdrawals exceed contributions or issued amounts.
Key points include understanding the financial and tax implications, such as the Section 455 tax charge and potential personal income tax liabilities.
It is crucial to take prompt action by exploring solutions such as repaying the loan, issuing dividends, or contributing personal assets.
The article highlights the necessity of consulting with professionals like accountants, tax advisors, and insolvency practitioners to effectively handle these intricate matters. It covers tactics like bed and breakfasting and the consequences of liquidation.
FAQs
1. What happens if your director’s loan account is overdrawn?
If your director’s loan account is overdrawn, it means you owe your company money. This can result in tax implications, such as the Section 455 tax charge, and potential personal liability if your company faces financial difficulties.
2. Can you close a company with an overdrawn directors loan account?
Yes, you can close a company with an overdrawn directors loan account, but the outstanding balance must be addressed. Options include repaying the loan, declaring dividends, or considering liquidation processes like MVL or CVL.
3. What is the 30-day rule for overdrawn directors loan account?
The 30-day rule prevents directors from temporarily repaying an overdrawn loan to avoid tax charges, only to withdraw a similar amount shortly after. If a repayment is followed by a similar withdrawal within 30 days, the repayment is ignored for tax purposes.
4. Can a limited company write off a directors loan?
A limited company can write off an overdrawn directors loan account, but it will be taxed as dividend income for the director, and employees NIC’s may apply. This option is typically less favourable due to double taxation implications.
5. How can I effectively manage my director’s loan account?
To manage your director’s loan account effectively, maintain accurate accounting records, plan withdrawals carefully, and consult with accountants or tax advisors. Consider strategies like declaring dividends or issuing salaries to balance the account.
6. What are the risks of an overdrawn director’s loan account in insolvency?
In insolvency, an overdrawn director’s loan account can become a personal liability. Creditors may pursue repayment, and insolvency practitioners can demand repayment plans. It’s crucial to address the overdrawn amount promptly to mitigate risks.
