Overdrawn Director’s Loan Account – Rules, Tax & Repayment

What is an overdrawn directors’ loan account?An overdrawn director’s loan account can pose serious financial issues for company directors, especially if the business is already struggling financially. An overdrawn account occurs when a director takes out more money from the company than they are entitled to or does not repay the loan on time.

In such situations, the company can suffer from reduced cash flow, which can lead to a decrease in investment opportunities, and the inability to pay creditors and suppliers on time.

If the company is already struggling financially, an overdrawn loan can make matters worse, as the company may be unable to pay wages or cover operating costs, which can ultimately result in the company going into administration or liquidation.

Moreover, an overdrawn director’s loan can have serious legal and tax implications. Under the Companies Act 2006, an overdrawn director’s loan is treated as a debt owed to the company and must be repaid within a specified period. If the loan is not repaid, the director can face disqualification or personal liability for the debt.

Additionally, an overdrawn director’s loan can be subject to income tax and national insurance contributions, which can further compound the financial issues faced by the company and the director. Thus, directors need to manage their loan accounts carefully to avoid the negative consequences of an overdrawn loan

What is an overdrawn directors’ loan account?

An overdrawn director’s loan account is a loan made by a limited company to one of its directors that has not yet been fully repaid. Limited company directors frequently withdraw funds from the company in ways other than dividends or salaries.

Directors of limited companies often take money out of the business in forms other than dividends or salary, resulting in a director’s loan account. This account records and documents the transactions between the company and the director, serving as proof of the loan’s existence. It’s important to note that an overdrawn director’s loan account occurs when a director takes more money out of the company than they’re entitled to or doesn’t repay the loan.

An overdrawn loan account can lead to significant financial problems, particularly if the company is already experiencing financial difficulties.

  • The director’s loan account will be zero if you don’t take any cash out of the business (aside from salary and profits).
  • The director’s loan account will be in credit and the company will owe you money if you inject personal funds into the business (maybe to purchase assets or equipment).
  • You would owe the company money if you took money out of the company since the director’s lending account would be in debit.

If the loan is not repaid, the company’s cash flow is reduced, leading to a decrease in investment opportunities and the inability to pay suppliers and creditors on time. It’s crucial to manage a director’s loan account carefully to avoid any adverse consequences. As long as the balance of the loan is repaid within nine months of the accounting period’s end, having a director’s loan account in debit isn’t an issue.

However, failing to do so can result in significant tax and personal liability issues, making it essential to maintain a healthy director’s loan account.

Disclosure of an overdrawn director’s loan account

It’s crucial to ensure that your company tax return accurately reflects the amount owed with a transparent disclosure. The presence of an overdrawn loan account can result in tax implications for the company, as the outstanding amount will be subject to corporation tax if it’s not repaid within nine months of the accounting period’s end.

It’s essential to ensure that all entries related to the director’s loan account are accurately reported and submitted on time to avoid any issues during a corporation tax compliance check. HMRC may question the presence of a director’s loan account at any time, and accurate record-keeping can help you avoid any potential legal or tax-related problems. Therefore, it’s vital to manage the director’s loan account carefully to prevent any adverse consequences for both the director and the company.

What are the tax implications of an overdrawn director’s loan account?

If you find yourself with an overdrawn director’s loan account, it means you owe the limited company money. It’s crucial to repay the loan within nine months of the accounting period’s end to avoid any financial penalties. Failure to do so will result in a corporation tax penalty of 32.5% of the loan, leaving the company to bear the brunt of the financial burden.

If the loan amount is over £10,000 and it’s interest-free or charged at less than commercial rates (which is common for most directors’ loans), HMRC will consider it as income taken out of the company. As a result, both the director and the company will be subject to income tax and national insurance implications.

In addition to these penalties, HMRC will also charge interest on the loan until the corporation tax levied on the loan or the director’s loan account is fully repaid. Thus, it’s essential to repay the loan on time to avoid any adverse consequences for the company and the director.

How is an overdrawn director’s loan account treated in insolvency?

An overdrawn directors loan is treated in insolvency as an asset of the company. While it may seem like a good idea to clear an overdrawn director’s loan account by voting the balance as a bonus or dividend, doing so can have dire consequences. If the company enters an insolvent liquidation, the liquidator will view the overdrawn director’s loan account as an asset that can be pursued to increase the repayment for the company’s creditors.

This is especially true if the sale of company assets does not cover the cost of liquidation or provide a substantial return for the creditors. The liquidator will take action to recover the director’s loan, which can put significant pressure on the director’s personal finances.

If the director is unable to repay the loan, their personal assets could also be at risk, and legal action could be taken to recover the funds, potentially forcing the director into bankruptcy. Compulsory liquidation, which can be initiated by a creditor such as a supplier or HMRC, can make matters worse for the company director.

In such cases, the Official Receiver who liquidates the company will investigate the circumstances under which the overdrawn director’s loan account was created, and this could lead to accusations of wrongful trading or misfeasance against the director, potentially resulting in a ban from operating as a company director for up to 15 years.

Can an overdrawn directors’ loan account be written off?

There are instances where an overdrawn director’s loan can be legitimately reduced, such as when the director has personally paid for business mileage or company assets. In some cases, a director’s loan account can even be completely written off. For example, in a ‘close company’ (a limited company with fewer than five shareholders), a director who is also a shareholder can write off their director’s loan by treating it as a distribution of profits.

However, if the director is not a shareholder in the close company, the outstanding amount will be taxed as employment income and must be included on their tax return. This could result in a considerable amount due, especially for those who pay tax at the higher rate and are required to pay National Insurance contributions.

Despite this, the story may not end there. If the company enters liquidation, the liquidator is required to exhaust every possible avenue to raise funds for creditors to be repaid.

In such a scenario, the liquidator may pursue the director for the amount in the overdrawn director’s loan account, even if the debt was previously written off.

Frequently asked questions

Can you close a company with an overdrawn directors loan account?

Yes, you close a company with an overdrawn directors loan account. In a close company, that is one with fewer than five shareholders and providing the director in question is also a shareholder, an overdrawn director's loan account can be treated as a distribution of profits and written off.

What is the interest on an overdrawn director's loan account HMRC?

The interest on an overdrawn director's loan account HMRC is 32.5% of the original loan, or 25% if the loan was made before 6 April 2016.

Conclusion

An overdrawn director’s loan account is a type of loan made by a limited company to one of its directors that has not been fully repaid. In simple terms, a director may take money out of the company without formally taking a salary or dividend. This can be done by taking out a loan from the company, which should be repaid within a certain timeframe. However, if the loan is not repaid in full, it becomes an overdrawn director’s loan account.

This can lead to potential tax implications for both the director and the company, and it may also affect the company’s financial position. Therefore, it is important for directors and their companies to manage their director’s loan accounts carefully and ensure that they are repaid on time.

If you are worried about entering insolvency with an overdrawn directors loan account and need to talk though your options, simply make an enquiry online today.

Insolvency & Restructuring Expert at Business Insolvency Helpline | + posts

With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.