Overdrawn Directors Loan Accounts 

Many directors use a loan account, which is generally fine. So you may be wondering what the issue is with directors loan accounts, the truth is that there’s only a problem when you take too much money from it and are unable to pay it back, in which case you end up with an overdrawn directors loan account. This can be particularly dangerous if you decide to liquidate your company due to business debts. 

How do directors’ loan accounts work? 

Directors’ loan accounts work in a similar way to normal accounts. It is common for directors to take money from their company in the form of a salary, dividends (if the company makes a profit) or a combination of both. 

If a director has taken too much money from the company, their directors loan account is overdrawn. If the director has loaned the company money, it’s in credit. In an ideal world a director should aim to keep the directors loan account at zero or in credit.

Sometimes a company may need a cash injection, in which case a director may decide to loan the company money. This results in a director’s loan being in credit. Or a director may need a short-term personal loan which it can borrow from the company. Both transactions are known as a directors loan.

These transactions between the company and the director must be recorded on the Directors Loan Account to ensure transparency. In addition, if there’s more than one director within the company, each director must maintain their own directors loan account. If your company enters liquidation, you will have to present this information so it’s important that it is kept up to date.

Directors loan accounts

What happens when a directors loan account is in debit?

Although borrowing money from the company is not best practice, the reality is that it happens and it is very common that a director of a business in the UK will have had an overdrawn directors loan account at some stage. Having an overdrawn directors loan account is not necessarily a problem as long as the money is repaid back to the company.  

At the end of the company’s financial reporting period, any money the company owes the director or vice versa must be shown in the company’s accounts and reported to HMRC, as there may be tax liabilities for both parties.

If a director owes the company money, the director has nine months and one day after the company’s accounting period ends to pay the company back. You may be wondering what will happen if you are unable to pay the business debts, if this is the case then the company will be liable to pay S455 corporation tax on the outstanding balance. The director will also have to pay tax through their self-assessment tax return. The current rate for S455 tax is 32.5% or 25% for loans made before April 2016.

The company can reclaim S455 corporation tax. However, this can be a bit of a drawn-out process. The director who has enjoyed the benefit of a loan from the company is not eligible to claim back any of the tax it has paid to HMRC.

Can a directors loan be written off? 

Even though there’s a legal separation between a director and a company, in the case of directors’ loans, these can’t simply be written off if a company is experiencing financial hardship.

So what happens to my overdrawn Directors Loan Account if I liquidate?

The most important advice we can give you is not to panic, there are many directors in the same position as you. What’s more, there are options for you even if it feels like liquidating your business is the best one.

When a liquidator is assigned, their job will be to scrutinise the directors loan accounts to look for any transactions which may have jeopardised the company’s financial future. As a result, running an overdrawn directors loan account up to and as a company enters liquidation can lead to serious personal financial difficulty.

If the liquidator finds that a director borrowed money from the company, which it could not financially support at the time, there may be severe repercussions, including:

  • Repaying the loan to the liquidator, the loan is an asset of the company and it is their duty to recover it
  • The liquidator beginning court proceedings for the monies owed
  • A 2-15-year disqualification as a director if misconduct is uncovered
  • Criminal prosecution if illegal activity is found.

A problem arises for a director if they place their company into liquidation and there is an overdrawn directors loan account. This loan sits as an asset of the company and the insolvency practitioner appointed to deal with the liquidation of the company has a duty to recover the loan back from the director and distribute it to the creditors of the company. 

When it comes to having an overdrawn directors loan account in liquidation it’s critically important that you understand what your position is, this means knowing what your overdrawn directors loan stands at and what you will do about it when the company goes into liquidation. This is not something to deal with down the line and please do not think that the insolvency practitioner will not find out about it or that they won’t check.

Insolvency meeting

How to deal with an overdrawn directors loan in liquidation

Start by taking a look at your last set of accounts and look for the section that says ‘debtors’, this is who owes the company money. It’s here that an overdrawn director loan could be published, it could also appear further down the accounts as a directors loan. This is a good starting point for you. Don’t rely on the ones at companies’ houses as these accounts may be shortened and don’t show you the full picture, check the last set of full accounts that were sent from your accountant.

Next, you need to work out what their up to date figure is, generally accounts are submitted for the previous year, so your director’s loan account could have gone up or down depending on how much money you have taken from the company or paid back since your last set of accounts.

You should look at all the transactions from the date of the accounts up until now, working out all the money paid from the company to the director, this will leave you with a figure. Then you subtract anything that has been paid through the PAYE scheme, any personal spending for the benefit of the company, you will need to be able to prove this, with receipts and invoices etc, and any money that you have paid back to the company. 

Completing these tasks should leave you with a worse case final balance of your director’s loan. We strongly recommend that you get some help doing this and we are happy to assist with no obligation so you understand your issue up front with no surprises down the line.

Financial advice

Do I need an insolvency practitioner to help with my director’s loan account?

The short answer is yes! An insolvency practitioner is there to represent the interest of creditors in an insolvency procedure. The role of an insolvency practitioner is to investigate a director’s loan account and then recover money from the director so it can be distributed to creditors. Although initially, an insolvency practitioner may be demanding that you have to pay all your directors loan back in one go, many will come to some sort of settlement with you, depending on your personal financial position and your ability to pay. In most circumstances, you will be able to agree on a deal where you repay a percentage of your overdrawn directors’ loan back. This figure will be based on things like, do you own a property, how much equity you have in the property, are you married, do you have any investments, and do you have any disposable income.

One thing is for sure, you will be able to agree to a better settlement with an insolvency practitioner if you do it before you appoint them. So many directors spend months worrying before they make an enquiry, when they finally speak to someone, they can almost be in a rush to get a liquidation over and done with. Our advice here is very simple, slow down and be willing to take the time to understand all the costs that you will incur by going into liquidation. An extra few days working out exactly what your directors loan account stands at and negotiating a settlement will not make much of a difference.

Need more advice?

If a business is flourishing, directors’ loans aren’t necessarily an issue, especially if they’re managed correctly. However, they can become a complex area of business as a company declines, so it’s essential to seek advice as soon as possible. If you’re concerned about any of the issues raised in this article, get in touch for some free impartial advice.

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