Are you thinking about leaving your company as a director? Then you’ll need to make sure that you’ve thought carefully about it and covered every aspect. In this blog, we’re looking at director’s loan accounts: legal treatment when a director exits the business.
What is a director’s loan account?
A director’s loan account is a separate record of financial transactions between a company and its director. In some cases, the loan account might be in credit, which means the director has lent the company money. Essentially, this means they have put more in than they’ve taken out. This is usually a good position to be in.
In contrast, a director’s loan account may be in debit, which means the director has borrowed money from the company. In this case, a director has taken more money out than they’ve put in. This can have tax implications and may need to be repaid.
The directors’ loan account acts as a running balance, but it does not include money withdrawn from the company for salaries, dividends, or expenses.
If the account is overdrawn, it means the director has withdrawn money from the company and therefore owes the company money.
What are the duties of a director?
When named as a company director, certain duties must be met. Generally speaking, directors should encourage the company’s success, act within their powers, exercise independent judgment, and maintain ethical conduct.
Whether the company is labelled as solvent or insolvent, the directors should be acting in the best interests of their shareholders. A solvent company is one that can pay its debts when they fall due, whereas an insolvent company is one that cannot afford to pay its debts when they fall due.
If directors fail to fulfil their fiduciary duties, they will face consequences, which may include fines and legal action. Directors are likely to be held personally liable for breaches of duties and they may even face disqualification. Read more about a director’s duties in insolvency.
What’s the best way to handle a director’s loan account?
The best way to handle an overdrawn loan account is to keep it in credit or at zero. If the loan account is kept at zero, then there are no debts from either the company or the director. It’s not uncommon for directors to use a loan account, but it’s crucial that you seek professional financial advice. If your company begins having financial difficulties, you must seek professional advice and identify the most appropriate way of dealing with them.
What are the tax implications of an overdrawn director’s loan account?
If a director chooses to have an overdrawn director’s loan account, then they may find themselves dealing with tax liabilities. These tax implications may be avoided if you can pay off the debt within nine months of the company’s financial year-end.
If a director fails to repay the loan within nine months, they will be required to pay an S455 charge, currently at a rate of 33.75% of the outstanding loan account balance. A director must adhere to these financial obligations regardless of the company’s financial situation.
Directors should seek professional advice on how to complete a self-assessment tax return based on the company’s financial position. Income tax liabilities may also be affected by the director’s loan account.
What happens to an overdrawn director’s loan account in liquidation?
If a company finds itself becoming insolvent, then it may look into liquidation methods. A creditors’ voluntary liquidation is a popular choice. If this liquidation method is chosen, then the overdrawn account becomes a company asset in the form of a debt owed by the director to the company.
Despite the asset belonging to the company, which is a separate legal entity, the director should still repay the loan. Most liquidation methods require a licensed insolvency practitioner to handle the process, and their role is to sell assets and identify other ways of making money to pay back creditors.
Insolvency practitioners are legally obligated to recover the outstanding loan balance from the director’s account, which means the director is personally responsible for it. Directors who fail to pay off the loans in liquidation could end up being personally liable or facing bankruptcy.
With this in mind, it’s always best to keep the account in credit or at zero. Your personal tax liabilities may change if you have an overdrawn director’s loan.
It’s also worth noting that directors should not pay off the loan as they enter liquidation, as this may be seen as a preference payment if there are other creditors who need to be paid. You should be extremely wary of how you handle financial transactions.
When you enter liquidation, your company’s financial records will be assessed for two to five years leading up to the insolvency.
What happens if a director leaves with a director’s loan account?
It’s not uncommon for directors to move on from their companies. However, there are certain issues that a director may face if they leave with an overdrawn loan account.
If a director leaves the company with an outstanding loan, they will need to repay it, as they are still responsible for the debt. The company itself can even take legal action against the former director if the money is not paid back.
In contrast, if the company owes the former director money, they can withdraw this without facing immediate tax consequences. Any transactions made to or from the account need to be correctly documented; otherwise, you may find yourself in trouble. Be aware that you may face personal liability for other company debts.
Ultimately, it’s best to keep the director’s loan at zero, especially if you plan to leave the company. In this case, the director should be free to leave the company without any issues. It’s important that all aspects have been considered before you make a decision to leave.
We hope this blog has been helpful regarding director’s loan accounts: legal treatment when a director exits the business. At 1st Business Rescue, we provide honest, professional advice for directors and can help with guidance on directors’ loan accounts. Contact us today for professional support.
Justin Barker
I’m Justin Barker, the Managing Director at 1st Business Rescue. I have over 25 years of experience providing insolvency advice to business owners.
I understand how challenging it can be when dealing with financial difficulties within your business. It’s easy to ignore the problem and hope that it disappears, but this is often the worst thing you can do. Our dedicated team is here to provide honest, valuable advice to help UK directors deal with their personal situations in the most appropriate way.
No case or circumstance is the same, but I can guarantee that I am there to give you the best advice.
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