Understanding an overdrawn director’s loan account

An overdrawn director’s loan account can lead to significant financial and legal implications and compromise a company’s financial stability. We offer detailed insights and actionable strategies to reduce any risks associated with them. 

When a director, or a close family member takes money from a company that is not a salary, dividend, expense or repayment of loan, a director’s loan is created. A director’s loan account is when directors in limited companies borrow money beyond their salary or dividends. 

A limited company is a separate legal entity to shareholders and directors. Any funds exchanged between the company and its directors can attract potential financial and legal implications. 

An overdrawn director’s loan account occurs when a director takes money from the company without timely repayment. An overdrawn director’s loan account presents significant implications for both the director and the limited company. Remaining informed and proactive to safeguard their interests and those of their company is vital for directors. 

Make sure you keep a record of any money borrowed from the company by directors, including dates. This is known as a director's loan account. This amount is included on the balance sheet in the company accounts. 

Legal and financial implications 

When you owe money to your company, the director’s loan account shows an overdrawn balance. The repercussions can be severe and affect the company and director.  

If the balance is not repaid within nine months after the company’s financial year-end, you may have to pay tax on the loan.  

Where a company faces insolvency, the consequences increase with tax penalties, personal liability for directors, and potential legal action. 

If the loan was more than £10,000 and you paid interest on the loan below the official rate, then you may have additional tax liabilities. 

Director’s loan account repaid within nine months of end of corporation tax period 

• Report the balance owed to the company on your company tax return using form CT600A “loans to participators by close companies”
• Where the loan is more than £5,000 and you took another loan of £5,000 or more up to 30 days before or after you repaid it, pay corporation tax at 33.75% of the original loan (where loan was made after 6th April 2022). This is known as section 455 tax (S455) and this corporation tax can be reclaimed after the loan is repaid. 
• Where the loan is more than £15,000 and you arranged another loan when you repaid it, pay corporation tax at 33.75% of the original loan (where loan was made after 6th April 2022). This corporation tax can be reclaimed after the loan is repaid.  

Director’s loan account repaid after nine months of end of corporation tax period 

• Report the balance owed to the company on your company tax return using form CT600A “loans to participators by close companies” 
• Pay Corporation Tax at 33.75% of the outstanding amount (where loan was made after 6th April 2022) 
• Interest on Corporation Tax is added until the Corporation Tax is paid, or the loan is repaid. 
• You can reclaim the Corporation Tax - but not interest. 

Where the director’s loan is written off and not repaid, or the company goes into liquidation 

• The company will need to deduct Class 1 National Insurance through the company’s payroll 
• The director will need to pay Income Tax on the loan through a self-assessment tax return 

If the loan is more than £10,000 at any time and you are a shareholder 

• The company must treat the loan is a benefit in kind 
• You must deduct Class 1 National Insurance 
• You must report the loan on your self-assessment tax return, paying income tax where due 

Anti-avoidance rules are in place to prevent directors repaying a loan only to take out another. These rules are known as "bed and breakfasting" and you will face Section 455 tax. 

Reducing the risks of an overdrawn director’s loan account 

Proactively managing a DLA is crucial to prevent an overdrawn status. Here are strategic measures to consider: 

1. Regular Review and Reconciliation: Frequently check the director’s loan account to ensure accurate recording of transactions and adherence to limits. 
2. Timely Repayment: Make sure to repay any borrowed amounts within the nine-month window to avoid tax penalties. 
3. Legal and Financial Consultation: Seek advice from licensed insolvency practitioners or financial advisors to navigate complex situations, especially in cases of insolvency. 

Handling Insolvency with an overdrawn director’s loan account 

The treatment of an overdrawn director’s loan account becomes particularly critical in insolvency.  

The company must explore all avenues to settle outstanding amounts. This may involve negotiating repayment terms and considering writing off the loan. You should carefully consider the long-term implications when making your decision, including the director’s personal financial situation and the company’s obligations to its creditors. 

The role of liquidation in recovering overdrawn director's loan accounts

During liquidation, an overdrawn director’s loan account is a potential asset for creditor repayment. The appointed liquidator will assess the director’s loan account’s status and take necessary actions to recover owed funds. 

Voluntary vs. compulsory liquidation 

The way a company enters liquidation can influence the treatment of overdrawn director’s loan account. Compulsory liquidation involves more rigorous examination of the company's financial dealings, including director’s loan account. It can lead to allegations of wrongful trading or inappropriate actions by directors. 

How TaxAssist Accountants can help 

We are available to help you understand your directors loan account and the implications of an overdrawn balance. Get in touch for a free, no obligation meeting, call us today on 01603 981640 or complete our online form. 

Last updated: 10th September 2024