Can I write off an overdrawn director’s loan account?

What are the implications if I cannot repay a director’s loan?

If you have an overdrawn director’s loan account, ordinarily it isn’t a problem. As long as you repay the loan within nine months of the company’s year-end, it should not affect you or the business detrimentally. The issue comes when you do not repay the loan in time or the business becomes insolvent. 

At that point, an overdrawn director’s loan account can become a thorn in your side. You may wish the company could simply write off the director’s loan, but is that possible and what are the implications?

What is an overdrawn director’s loan account?

As a company director, if you take money out of your limited company that isn’t a salary, dividend or the repayment of expenses, it is recorded in your director’s loan account (DLA). A DLA is a record of the financial transactions between a director and the business. 

It is common for a director to take money out or pay money into the business in the form of a loan. When a director pays more money into the company than they take out, the director’s loan account is in credit, and the director can draw on that balance without tax or National Insurance implications.

When a director takes more money out of the business than they put in, the director’s loan account becomes overdrawn. Rather than pay the money back, you might wonder whether you can simply write off the overdrawn director’s loan account. While it is possible, there are tax implications and the consequences could be more serious if the business becomes insolvent.

What happens when a director’s loan account is overdrawn? 

An overdrawn director’s loan account in itself is not necessarily a cause for concern. Issues arise if you do not repay the loan within nine months of the company’s year-end. In that case, you must pay 33.75% Corporation Tax on the loan amount and interest until the outstanding tax or the loan is repaid. 

The other issue is if the business becomes insolvent. If the company enters insolvent liquidation with an overdrawn director’s loan account, it will become an asset of the business. The liquidator will seek to recover the money so it can be used to repay the creditors. If you do not repay the loan, the liquidator can pursue you through the courts if necessary. In the worst-case scenario, that could lead to bankruptcy and put personal assets such as your home at risk. 

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How can I repay an overdrawn director’s loan account?

There are several ways you can repay an overdrawn director’s loan account.

Pay a dividend

One method is to vote to pay a dividend that clears the overdrawn director’s loan account. Before you do, you must ensure the company has sufficient profits to pay the dividend. If the company becomes insolvent and enters liquidation less than two years after the dividend payment, the liquidator could deem it unlawful and ask you to repay it. 

Take extra salary

Another approach is to pay yourself an additional salary as a bonus to clear the loan. Again, you must ensure the company has sufficient funds to pay the bonus and the PAYE and NIC it will incur. You must be aware of the company’s financial position when making this payment as it could be challenged by a liquidator if the company subsequently becomes insolvent. They may argue that it was not in the business’s best interests and you could be forced to repay it. 

Use unclaimed expenses

If you have expenses you have not claimed for the taxable period, you could put them towards the repayment of the director’s loan. However, you must be able to justify the expenses and have sufficient evidence of them.

Clear it with personal funds

The simplest way to repay a director’s loan account is to use your own funds. That will not bring any tax implications if you repay it in full within nine months of the company’s year-end.         

Write it off

If the company cannot afford to pay an additional dividend or salary and you do not have the personal funds to repay the director’s loan, another option is to write it off. The company effectively agrees not to collect the outstanding balance and it will be treated as a deemed dividend for tax purposes. 

In this case, there’s no requirement for the company to have the available profits to pay the dividend. The company will need to pay Class 1 NIC on the amount and the director must include it in their Self Assessment tax return and pay dividend tax on it. 

The issue here is if the company subsequently enters insolvent liquidation. In that case, the liquidator will treat the written-off director’s loan as a company asset and seek to recover the money for the benefit of its creditors.  

Can I write off an overdrawn director’s loan account in liquidation?

When you take a director’s loan from the company, you’ll usually do so with the assumption that you’ll have no problem paying it back. Unfortunately, that’s not always the case. A downturn in the company’s fortunes could mean you’re unable to take your usual salary or pay dividends, which may affect your ability to clear the loan account. 

If you cannot repay the loan and the company enters liquidation, you might assume the debt will be written off as part of that process. However, as the debt lies with you and not the company,  that’s not the case. The liquidator will view the director’s loan account as a company asset and expect you to repay it to increase the funds available to the creditors. 

How is an overdrawn director’s loan account treated on liquidation?

When you enter liquidation, the licensed Insolvency Practitioner acting as the liquidator will examine the company’s financial affairs in detail. If they find a director’s loan has not been repaid or was formally written off in the previous two years, they will likely view it as a company asset and take steps to recover it for the benefit of the creditors. 

If you cannot repay the loan in full, most liquidators will be willing to negotiate a settlement that gives you more time to pay what you can. Although they can pursue you through the courts and initiate bankruptcy proceedings, making a settlement is less expensive and time-consuming and typically produces a greater return for the creditors. However, bankruptcy proceedings are still possible, particularly if you have significant equity in your home.

You could also face repercussions from the Insolvency Service if the liquidator believes the presence of the overdrawn director’s loan account contributed to the company’s failure. In that case, you could face other financial and legal consequences, such as personal liability for company debts or a director disqualification. 

Need advice?

If you have an overdrawn director’s loan account you are struggling to repay, seek professional advice at your earliest opportunity. At Real Business Rescue, our team of licensed Insolvency Practitioners will assess your situation, explain your options and provide practical solutions to get you back on track. Get in touch for a free consultation or arrange a meeting at one of our 100+ UK offices.