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Understanding Overdrawn Director's Loan Accounts - Including Repayment, Interest & Tax
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What is an Overdrawn Director's Loan Account?
An Overdrawn Director's Loan Account is where more money has been taken out of a company than has been paid in. Directors often take money out of the company in this way which is not classed as a salary or dividend; however, if this money remains unpaid, the director will be seen as benefiting from a loan from the company and must pay tax on this amount accordingly.
A director’s loan account is a record of company financials which documents any transactions between the company and the director, aside from salary and dividends. When you don’t take money out of the company (which is not classed as dividends or payroll) your director’s loan account will have a zero balance or possibly be in credit if you have put your own money into the company or used personal funds for expenses or company assets.
The complexities arise once a director’s loan account becomes overdrawn.
A director’s loan account can be a particularly complex issue for company directors to understand. Unlike with sole traders or Partnerships where taking money from the business is a relatively straightforward process, withdrawing money from a limited company in this manner is a different matter altogether.
This is because a limited company is classed as a separate legal entity from its directors, therefore the company's money belongs to the company and not the directors. Taking money out of a limited company requires some additional considerations.
An overdrawn director’s loan account is where you, as a director, have taken more money out of the company (that is not classed as salary or dividend) than you have put in.
Having an overdrawn director’s loan account isn’t necessarily a problem so long as these transactions are accurately recorded and you can afford to repay it or offset it within nine months of your company’s year end. If you find yourself unable to repay your director’s loan on time, however, this is where the problems arise.
Whilst left unpaid, this loan is considered an asset of the company – a crucial matter should the company later become insolvent.
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When a company becomes insolvent, it is common that a director will have an overdrawn director's loan account at this stage. It’s common for directors to ‘help themselves’ to company funds with the view of paying it back in the long run, only for the company to experience a nose-dive in profits and run into problems before this can be done.
Overdrawn director's loans can become a major issue should the company become insolvent and is placed into liquidation. In formal liquidation proceedings, any overdrawn director’s loan account would be considered a company asset. The next step can often depend on the value of the director’s loan, the amount the company owes to creditors, and the decision of the liquidator whether to pursue the director or not.
If the balance of the overdrawn director's loan is significant, the appointed liquidator will almost certainly look to the directors to repay the outstanding loan amount back to the company so that the money could go towards repaying outstanding creditors as far as possible.
Even if the company itself has ‘written off’ the loan, a liquidator is able to reverse this and ask that the company director repays the overdrawn director's loan account in order to satisfy creditors. An overdrawn director's loan cannot be swept under the carpet just before the business goes into liquidation to avoid paying creditors; historical accounts and invoices will be scrutinised and money will be tracked to ensure proper processes have been carried out. This is a liquidator’s duty.
But what happens if the director cannot afford to repay their overdrawn director’s loan account in liquidation? Unfortunately it may be the case that a director has to consider personal insolvency proceedings, such as an IVA or bankruptcy, if they are unable to repay their overdrawn directors loan account or otherwise come to an agreement with the appointed liquidator regarding how much is owed.
There might be legitimate ways to reduce the balance of an overdrawn director's loan account and thus reduce your personal liability. For example, you may have reasonable claims for expenses such as equipment bought for the company using personal funds, unclaimed business mileage, or other similar expenses. This may be able to reduce an overdrawn director's loan account to a certain extent, but for many, the remaining balance will still be too great to deal with.
Overdrawn director’s loan accounts can occasionally be written off, however, if the value of the loan is deemed insignificant by a liquidator. In an insolvency process, it is normal for the director to repay their director's loan account in order to create funds for creditors but if this figure is relatively small, the liquidator could decide that there are insufficient assets to carry through a formal liquidation process and, instead, look to have the company struck off the register.
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Directors cannot take money from a company and not either repay it in full or pay tax on the amount taken. HMRC won’t necessarily view your director’s loan as personal income; instead they have a specific set of rules that apply to individuals in these circumstances.
If your overdrawn director’s loan account remains overdrawn nine months after the end of your company’s accounting period (year-end), the company will be subject to a rate of tax known as Section 455, or S455. This tax is charged to the company at a rate of 33.75% for loans made on or after 6 April 2022, 32.5% for loans prior to this and 25% for loans before 6 April 2016.
This is wholly irrespective of corporation tax; it makes absolutely no difference whether your business has made profits or losses or whether it has paid its tax or no tax – this S455 tax charge on the overdrawn DLA is still payable. It needs to be paid, as with standard corporation tax, nine months after the end of your company’s accounting period.
If this S455 tax is paid on time, i.e. nine months after your company’s year-end, this tax payment is refundable. However, recovering this tax payment can be a long and winding process with HMRC stating that ‘repayment of the S455 tax is deferred until nine months after the end of corporation tax accounting period in which the loan is repaid or reduced.’
Sometimes a company will try to reduce the amount of the overdrawn director's loan account by declaring the balance as a dividend or bonus . But if the company then goes into liquidation, this could be setting the company and director up for a massive fall.
During liquidation, all recent company affairs including accounts and transactions and will be investigated by the appointed insolvency practitioner. If it transpires that creditors are missing out on payment they are owed whilst a director has taken a huge dividend or bonus to clear an overdrawn director’s loan, this could raise legitimate claims against the director.
The director will need to prove that that particular dividend/bonus was in the best interests of the company and its creditors but, considering the company’s precarious position, this will be very hard to justify to the liquidator. It is likely to be the case that the director is asked to repay the overdrawn director’s loan amount back to the liquidator who will then use these funds to pay creditors. In insolvency, it is crucial to ensure all creditors are treated the same so a company bank account will be scrutinised for payments where someone, i.e. the director, received preferential treatment.
However, if the director is unable to repay the overdrawn loan account figure, HMRC will look to levy income tax and National Insurance Contributions on the money taken.
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If you have an overdrawn director’s loan account and you are unable to repay it nine months and one day after your company’s year end, HMRC will charge the company interest on the loan and this will accumulate until the S455 corporation tax or the director's loan is repaid. You can reclaim the corporation tax at a later date but not the interest paid on it – which is 2% for the 2022-23 tax year.
If you are unable to repay your overdrawn loan back into the company, this is likely to impact on creditors. A liquidator will assess the amount of the overdrawn DLA and will look to realise funds in the best interest of creditors. From their perspective, you have taken money from the company that belongs to the company and this company owes them money. So in effect, you have spent their money.
The liquidator will look to recover this money, particularly where the overdrawn loan account and other assets are sufficient enough to cover their costs and release some funds for creditors. The situation changes slightly if the company has already been served a winding up petition by a creditor such as HMRC or a disgruntled supplier. This would create a situation where the official receiver becomes involved who, upon assessing the circumstances and the overdrawn director’s loan, may accuse the director of wrongful trading and/or misfeance which can have serious consequences possibly even including director disqualification. You should seek advice from one of our licensed insolvency practitioners at the earliest possible opportunity if this situation has arisen; we have offices around the country and a business rescue specialist can speak with you face-to-face, at no cost, and offer independent advice.
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Further Reading on Overdrawn Director's Loan Accounts
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