Overdrawn Directors' Current or Loan Account
Well, usually the company is making some profits and your accountants advise you to save tax by paying your directors a small salary and then you take dividends from the reserves of profits made in the past and current years. So off you go taking money out of the business as instructed.
THEN something goes wrong!
Although the accountant's advice is generally sound from a tax reduction perspective, when a company is performing well; If the business starts to perform badly then directors can end up with serious personal liability problems.
All accounts filed at Companies House should refer to any overdrawn current accounts as loans to the director concerned. You must try to get these paid back or reversed in subsequent periods as HMRC will tax you on a fairly penal rate if you do not. If the company has no distributable reserves, it cannot pay dividends. So, if your company's balance sheet starts a year with nil or negative reserves, then if you make no profit you MUST STOP taking dividends as soon as you are aware of this.
It is much better to pay yourselves through PAYE and pay the tax/NIC. If the company cannot afford to pay you GROSS then it is likely to be insolvent.
What can we do? Options include:
- Repaying the loan you personally owe to the company.
- Offseting any loans the directors have made to the company (this is called set off).
- Taking your full salary but reduce the cash you take out of the business to gradually offset the account. So pay yourself 4,000 per month but take 1,000. Remember to pay tax on the 4,000!
- Making lots of profits in future periods to offset it!
- Use a Company Voluntary Arrangement to restructure the company. (KSA Group are experts at this - want to know how to fix the problems your company faces - see our CVA section - the best rescue mechanism).
What happens in liquidation if we have overdrawn current or loan accounts?
In liquidation, the liquidator can demand that directors repay their overdrawn director's current account to the company for the benefit of the creditors. They can take legal action to make directors pay this or even make you bankrupt.
This means you could lose your house if your directors' current account is overdrawn and not recovered.
So here is an example case study/guide. If you need more detail call us now.
See if this rings any bells and then call us for help.
Mr Jones and Mr Smith set up a limited liability company based in London. It is a design and marketing company and they formed it in 2001.
Sales built quite quickly based upon the contacts in the marketing sector and the company grew to £1.2m sales. Their accountants told them that the company had made £80,000 net profit in year 1 and that this would be taxed for corporation tax purposes at roughly 20%.
So he advised them to leave their PAYE salaries at a lower level each month in year 2 and take dividends from the reserves and future profits.
This they did for a number of years and paid themselves quite well as the company was profitable each year.
Then that "something happened".
Their biggest debtor went bust owing the company c. £158,000. Silly to let that debtor take as much credit in my view, but their view was "after all the company was a well known big name customer and we never thought it would fail". And it was good regular business for them so we understand why it got to be such a big debtor.
This led to a situation that was clearly not planned for. In 2006 the company had a bad trading year on top of the failed customer, and so had to write the bad debt off. This made a huge loss for the year of £250,000. As a result the balance sheet then became negative (see insolvency test) and they saw the first flashes of a cashflow crisis looming.
So no further dividends could be taken AND the directors now had overdrawn directors' current accounts to the tune of 50,000 in that accounting year. With cashflow pressure mounting they came to KSA Groupand said they needed to restructure the company or close it.
This was our advice: Set out your objectives, look at the viability of the company and then make a decision to ACT.
Call KSA Group in and we will set out the options in writing and in expert detail - that will help you decide.
A CVA was used and the current account problems solved.
If the company entered a formal terminal insolvency like administration, receivership, voluntary liquidation or compulsory liquidation, then the insolvency practitioner/liquidator could have demanded that the directors repay the £50,000 back to the company for the benefit of creditors.
This could have caused them personal financial hardship and with personal guarantees to the bank of over £200,000 the last thing they wanted to do was liquidation or administration. Indeed it was likely that personal bankruptcy would follow.
The key test of any business in trouble is viability. We felt that one bad year and a huge bad debt did not equate to a bad business. Far from it. This was a good business with dedicated directors and staff. So, we said look at Go options and try and select the best option with our help.
We recommended that CVA would be the best solution and this was why; We recommended that CVA would be the best solution and this was why; the directors' drawings for the current financial year were treated as being net pay through the PAYE scheme in that year because there were no distributable profits, therefore dividends could not be paid. The prior year overdrawn directors account was repaid to the company in 6 months ( HMRC requirement), by the directors.
This of course generates a larger PAYE and NIC liability. But using the CVA the debt would be bound by the process. Along with reduction in people and managers (the lost contract meant that they had too many people) the company was forecasting a modest profit at best or just below break-even at worst.
- The benefits for creditors were that they got a deal paying 55% of their old debt back over 5 years, and kept their customer.
- The benefits for the company were a downsized business, lower costs, long term survival, no lost contracts and we removed cashflow pressures whilst keeping the bank happy.
- The benefits for the directors were that they avoided personal liability, avoided the failure, avoided bank personal guarantees being called up, and also avoided the 50,000 debt to the company.
- Plus as owners of the company they have long term employment and a valuable future business. So if you or your directors have an overdrawn current account and a company that is under real pressure then call us on 0800 9700539. As the above case shows we can save your business and help you as directors.
Don't you deserve to save your company and look after your own personal financial situation?
Author: Keith Steven
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