An Overdrawn Director’s Loan Account happens when a director owes the company money. This comes about when the company makes profits and the accountants advise on saving tax and keeping National Insurance at low levels, by paying directors a small salary but the company doesn’t have requisite reserves.
Normally, directors take drawings every month from the reserves of profits in the past and current months. The problems start when the company stops making profits.
Usually, at the end of each month, quarter or year, the board votes on paying dividends to the shareholders. This way the drawings are cancelled and dividends are voted through to cover the drawings.
Such an account is not too bad, so long as you can afford to repay it and keep track of the transactions. It becomes more of an issue when the business starts to perform poorly… directors can even end up with severe 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 any loan paid back or reversed in subsequent periods, as HMRC will tax YOU PERSONALLY at a fairly penal rate if you do not.
When the director’s loan account becomes overdrawn, it is classed as a company asset. To avoid the account fitting the ‘overdrawn’ category, the loan must be paid back within 9 months of the end of the accounting period.
FACT: 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. Taking drawings that cannot be covered by dividends is essentially taking the company’s money out as a loan — and you owe it back as a debtor.
The same situation occurs if you take a loan from the company to pay for something unexpected. Though you may intend to pay it back, it rarely ever is!
A director can borrow from their own company provided that it is not in financial difficulty and follows the rules as set out in the Companies Act 2006 and the company’s articles of association.
Taking loans from companies can complicate the tax affairs of both the company and the director. It is much better to pay yourselves through PAYE and pay the tax and National Insurance Contributions.
If a company goes into insolvency and the loan account is outstanding (and for three quarters of insolvent companies, a DLA is likely to be involved) the appointed liquidator will look to recover the debt for the benefit of creditors.
In such circumstances, options include:
You will still typically have to repay the loan within 6–12 months.
The directors should try and pay back the loan. The liquidator will demand repayment for the benefit of creditors. Legal action can be taken to make directors pay this, which could even lead to personal bankruptcy.
It is the liquidator’s duty not to let this be ignored and to ensure the loan is repaid — insolvency is not a way to avoid paying creditors.
When taking money from the company, it must be classed as a taxable benefit. This is because the company has lent money to you, i.e. it is a benefit which is not part of your salary. This is known as a ‘Benefit in Kind’.
HMRC sees it as an interest-free loan because you are benefitting from it — hence the reference to a ‘beneficial loan’. However, this does not apply in all cases. For example, if the loan is under £10,000, if the company charges interest, or if the loan is used for certain purposes (such as purchasing an interest in a partnership).
If the overdrawn director’s loan account still exists nine months after the end of the company’s accounting period, HMRC charges a penal tax known as Section 455 (S455) at a rate of 25%.
In summary, the director will be taxed on the benefit received.
Mr Jones and Mr Smith set up a limited liability design and marketing company in London.
Sales quickly built to £1.2m based upon their contacts in the sector. Their accountant told them the company had made £80,000 net profit in year one, which would be taxed for corporation tax purposes at roughly 20%.
The accountant advised them to leave their PAYE salaries low in year two and to take dividends from reserves and future profits. They did this for several years and paid themselves well, as the company was profitable each year.
Then disaster struck. The company’s biggest debtor went bust owing c. £158,000. Silly to let that debtor take so much credit in our view, but their view was “it was a big-name customer, and we never thought it would fail.”
On top of that, in 2010 the company had a bad trading year and had to write the bad debt off. The company made a £250,000 loss, the balance sheet turned negative, and cash flow pressure loomed. No further dividends could be taken, and the directors now had overdrawn directors’ loan accounts of £50,000 that had to be repaid somehow.
Our advice: set out your objectives, assess the viability of the company, and ACT.
Referring back to the case study, if the company had entered formal insolvency (administration, receivership, voluntary or compulsory liquidation), the insolvency practitioner could have demanded repayment of the £50,000 for the benefit of creditors.
The critical test of any business in trouble is viability. One bad year and a substantial bad debt did not equate to a bad business — far from it.
In this case, a CVA would be the best solution. The directors’ drawings for the current financial year were treated as net pay through PAYE because there were no distributable profits. Dividends could not be paid. The prior year’s overdrawn directors’ account was repaid to the company within six months (an HMRC requirement).
Yes, this generated a larger PAYE and NIC liability, but using the CVA meant:
Written ByKeith Steven
Turnaround Director
Keith is the Turnaround Director of RMT KSA Insolvency Practitioners which has been established for 25 years. The company has undertaken more CVA led rescues than any other firm. Read our case studies to see how.
