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. 

The director’s loan account is a record of the DRAWINGS transactions between the director and the company itself, excluding salary and dividends. At the end of each financial year this account needs to be reconciled and paid, or more tax will become due.

All this is fine, provided the company makes a profit and pays corporation tax before allocating dividends to cancel out the loan.

But if the company struggles and is not making a profit and therefore cannot pay dividends to shareholders, then the result is that the director owes money to the company as a loan called 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. If you fail to do 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, 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. 

So what happens if a director’s loan account is overdrawn in insolvency and what are the ramifications for you as a director if you can’t afford to repay?

Operating an overdrawn director’s loan account during the time leading up to insolvency, and when the company enters liquidation, can result in serious financial difficulty for you on a personal basis.

Ultimately, if a company goes into a form of insolvency and the loan account is outstanding, the appointed liquidator or CVA supervisor will look to recover the debt for the benefit of the creditors.

In such circumstances, options include:

• Repaying the director’s loan in full over time
• Offsetting any loans, the directors have made to the company (this is called set-off)
• Taking your full salary but reducing the cash you take out of the business to gradually offset the loan account. I.e., pay yourself £4,000 per month but take £1,000 – remembering to pay tax on the £4,000.
• Make higher profits in future periods to allow dividends to be paid

What Happens to the Director’s Loan Account in Liquidation?

The liquidator will demand that directors repay their debt to the company for the benefit of the creditors. Legal action can be taken to make directors pay this, which could even lead to personal bankruptcy. Your personal means may need to be ascertained by the liquidator to determine if you cannot afford to repay the loan. It is a liquidator’s duty to ensure the loan is repaid.

The liquidator’s overall responsibility is to the company’s creditors – they have a duty to realise the business’ assets and collect in all debts for the benefit of creditors. Although there is a legal separation between you and the company, in these instances directors’ loans cannot simply be written off when the business experiences financial difficulty.

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.  

The safe way to pay yourself as a director/employee is through PAYE; the risky way is to take DRAWINGS and hope the company makes sufficient profit to pay a DIVIDEND that cancels out the loan annually.

So what should you do if you’re worried that your business will be liquidated and you’re running an overdrawn director’s loan account? It’s vital that you seek professional support as soon as possible, to find out your best options.

Directors’ loan accounts aren’t necessarily a problem if they’re regarded as short-term financial facilities and are handled correctly. All loans must be properly documented, and those over £10,000 approved by shareholders. Additionally, if you repay in full within nine months and one day of the company’s year-end, you won’t be liable for tax.

We’re insolvency specialists and will provide independent advice on your situation. Please contact one of the team members to arrange a free same-day consultation.