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Overdrawn Director's Loan Accounts in Insolvency

18th July, 2023
Keith Steven

Written ByKeith Steven

Managing Director

07879 555349

Keith is the author of the content on this comprehensive rescue, turnaround and insolvency website. He is the managing director of KSA Group Ltd - a specialist firm of turnaround and licensed insolvency practitioners. Keith was nominated for Turnaround Practitioner of the Year 2014 at the National Insolvency and Rescue Awards in 2014.

Keith Steven
  • What Is A Director’s Loan Account?
  • How are overdrawn director’s loan accounts treated in the filed accounts?
  • What if the directors are loaned money from the company?
  • What can be done about the director’s loans if the company goes into any form of insolvency?
  • What are the Tax Implications?
  • A case study on Overdrawn Directors’ Loan Accounts

What Is A Director’s Loan Account?

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 but the problems start when the company stops making profits.

Usually, at the end of each month, quarter or year, the board vote on paying dividends to the shareholders. This way the drawings are cancelled and the dividends are voted through to cover the drawings.

Such an account is not too bad, so long that 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.

How are overdrawn director’s loan accounts treated in the filed accounts?

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 on 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. You should not take drawings that cannot be covered by non-existent dividends as essentially you are taking the company’s money out as a loan, AND THEREFORE YOU OWE IT BACK AS A DEBTOR.

What if the directors are loaned money from the company?

The same situation occurs if you take a loan from the company to perhaps pay for something unexpected. Though you 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. The shareholders must approve loans over £10,000, but less than £50,000, and the directors will need to agree to the loan terms such as the term and any interest charged. Taking loans from companies can complicate the tax affairs of the company and the director. It is much better to pay yourselves through PAYE and pay the tax and National Insurance Contributions.

What can be done about the director’s loans if the company goes into any form of insolvency?

If a company goes into a form of insolvency and the loan account is outstanding, (which 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 the creditors, as of course, they will be acting with the creditors interests at heart.

In such circumstances options include:

  • Repaying the director’s loan, as ultimately you owe the company
  • Offsetting any loans the directors have made to the company (this is called set-off)
  • Taking your full salary but reducing the cash you take out of the business to gradually offset the loan account. I.e. pay yourself £4,000 per month but take £1,000 and remembering to pay tax on the £4,000.
    Make high profits in future periods to allow dividends to be paid!
  • Use a Company Voluntary Arrangement (CVA) to restructure the company
    You will still have to repay the loan within six months typically.

What Happens in Liquidation?

The liquidator can demand directors repay their debt to the company for the benefit of the creditors. Legal action can be taken to make directors pay this, which could even lead to personal bankruptcy. It is a liquidators duty to not let this be ignored and ensure the loan is repaid…it is not a way to avoid paying creditors.

What are the Tax Implications?

When taking money from the company, it must be classed as a tax, being subject to a tax charge. This is because the company has lent money to you i.e. it is a benefit which is not a part of your salary. This is known as ‘Benefit in Kind’. HMRC see it as an interest-free loan as you are benefitting from it hence the reference, ‘beneficial loan’. However, this is not for all cases; if the loan is under £10,000, if the company charges the director interest and/or if the loan is used for certain purposes such as purchasing an interest in a partnership.
Moreover, if the overdrawn directors loan account exists in the nine months after the end of the company’s accounting period, a penal rate of tax known as Section 455 of S455 will be charged at a rate of 25%. Read more about S455 here.

S455 is charged, corporation tax or not, if your business has made a profit, seen a loss, or has already paid its tax…no exemptions. Only if the charge is paid on time (9 months after the company’s year-end) can you have the payment refundable (but as you can imagine, this is is a long-winded process!).

If you cannot repay the loan account nine months and a day after the company’s year end, HMRC charge interest on the loan which adds up until the S455 corporation tax or the director’s loan account is repaid. Only the corporation tax can be reclaimed at a later date, not the interest (at a rate of between 3-4%) paid.

In summary, the director will be taxed on the benefit received.

A case study on Overdrawn Directors’ Loan Accounts

Mr Jones and Mr Smith set up a limited liability design and marketing company based in London.

Sales built quickly to £1.2m, based upon their contacts in the marketing sector. Their accountant told them the company had made £80,000 net profit in year one and this would be taxed for corporation tax purposes at roughly 20%.

The accountant advised them to leave their PAYE salaries at a lower level each month 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 something happened. The company’s biggest debtor went bust owing the company c. £158,000. Silly to let that debtor take as much credit in our view, but their view was ‘after all, the company was a well known big name customer, and we never thought it would fail’. It had been good regular business for them, so we understand why it got to be such a big debtor.

The company’s failure led to a situation that was not planned for. In 2010, the company had a bad trading year on top of the customer’s insolvency, and so had to write the bad debt off. Therefore, the company made a significant loss for the year of £250,000. As a result, the balance sheet became negative, and they saw the first flashes of a cash flow crisis looming. No further dividends could be taken, and the directors now had overdrawn directors’ loan accounts to the tune of £50,000 in that accounting year that had to be paid back somehow.

Our advice in this situation would be to set out your objectives, look at the viability of the company and then make a decision to ACT.

Insolvency Options

Referring back to the case study, if the company entered 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 to the company 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. The company in the case study showed dedicated directors and staff.

In a case like this, we would recommend a CVA would be the best solution. 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’s overdrawn directors’ account was repaid to the company in six months (a standard HMRC requirement) by the directors. This, of course, generates a slightly larger PAYE and NIC liability. But using the CVA, the debt would be bound by the process. Along with the reduction in employees 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.

Creditors would benefit as they get a deal paying 55% of their old debt back over five years, and they kept their customer.

The benefits for the company are a downsized business, lower costs, long term survival, no lost contracts. We removed cashflow pressures while keeping the bank happy.

Directors would be able to avoid:

  • Personal liability
  • Business failure
  • Bank personal guarantees being called up
    Plus as owners of the company, they would have long term employment and a valuable future business.

Worried Director What Will Happen To Me After Liquidation?

in Company Liquidation What is …?

"A man in the pub said I cannot be a director of any other company if I liquidate my company. Is this true?"Actually, this statement is entirely false! Misconceptions like this frequently arise from individuals with limited understanding of the subject matter. Such misinformation can cause undue anxiety for directors considering liquidation, fearing it might personally affect them. Guess what? Listening to bar room experts, inexperienced accountants, or no insolvency specialist lawyers can stop decisions being made, this failure to make a decision is really what could land you in trouble. So how will liquidation affect me and how long does it take? Having a limited liability company means that the directors have little risk (or limited liability) if the company fails, as long as they have acted properly and acted in time. What is more, if as a director, you have been compliant and on the payroll for many years, you can actually claim redundancy from the government like any other employee. But, and it is a big but, if you fail to act in time, fail to act reasonably, fail to keep books and records, continue taking credit KNOWING that the company cannot possibly repay it, then you ARE at risk of personal financial loss or worse such as losing your house. So, act now and get help for your company and more importantly start reducing your own risks.Voluntary liquidation is the quickest most efficient way to deal with an insolvent company that has no future. As a director of an insolvent company, you are at risk if you do not act. This risk RISES the longer you don't act to put the company into liquidation.If you fail to act and the company is wound up by the creditors (compulsory liquidation) then the Official Receiver (OR) will be appointed to liquidate the business and he or she will investigate the activity of the directors and the business over the last 2-3 years. This is known as a conduct report on each director.  If the OR can prove there was wrongful trading where, for instance, you have taken credit from a supplier or took deposits from customers when you knew that it was highly unlikely that you could pay them back, then you could be made personally liable.This is known as the "lifting of the veil of incorporation" that protects directors under limited liability. If this happens then you could made liable for PAYE, VAT and creditors monies from the time that you should have known the company had no reasonable prospect of surviving the problems it faced.Additionally, the directors may face disqualification proceedings under the Company Directors Disqualification Act 1986 for up to 15 years, they can be fined and may face the loss of personal assets like your home, or even personal bankruptcy.Look, if you as directors have acted naively you may not know that you have broken these laws, but now you do know, it is vital to ensure that you protect yourself as a director by acting quickly to cease trading and put the company into voluntary liquidation; or consider a company voluntary arrangement if the company is VIABLE if the problems are solved. What is Creditors Voluntary Liquidation and what does it mean for me? In short, liquidation usually means, the company's trading stops and it's assets are turned into cash or "liquidated".All other possible liabilities, like employment liabilities, landlord's rent or payments to lease companies are stopped. It really is the end of the company, but the "business" may survive if a phoenix is organised. Liquidation is a powerful way to END creditor pressure and let you get on with your life. What if I have signed personal guarantees? If you have signed personal guarantees or indemnities to lenders, then the liquidation could lead to them being called in if the bank cannot get its money back from the company. There is little that can be done about that, but you should not delay decisions on liquidation to try and prevent a PG being called in: just think what ALL of the company's debts landing on your shoulders would do. Also it should be noted that HMRC now rank ahead of floating charge holders in any liquidation since December 2020.  Consequently, this may well mean that lenders that you have personally guaranteed will get less recovery hence exposing you more.All banks will agree a deal to repay the PG over time - provided you work with the bank to reduce their exposure.One great piece of FREE advice - always make sure that ALL tax returns, VAT returns and annual returns have been completed and sent in and that other "compliance" issues are dealt with wherever possible. These are important processes and will help protect you as individual directors. It shows that you have been acting properly.  I have heard about directors being able to claim redundancy in liquidation If you have been employed by the company and made payments via PAYE then you will be able to claim redundancy from the government and this is in fact a very simple process (20 minutes to fill out a form and we can help with that) so there is no need really to employ a third party to make a claim.  This process has been open to fraud so the HMRC are cracking down on operators that claim to be able to get money back when there is not enough "paperwork".  It isn't worth the risk.  If it sounds too good to be true then it probably is!You need to learn more about the options. This is clearly a general guide so, if you have any worries at all, please, just call us and we will talk you through the situation free and with expert guidance for your situation. Call one of our advisors or if you prefer, call our IPs (insolvency practitioners) now:Just one CALL will help relieve the stress and get you out of the mess.Why not call 08009700539 or 020 7887 2667 now?We could help you start the liquidation process today.(8.15am till 5.00pm; Out of hours call on 07833 240747, Wayne Harrison (IP)  or Eric Walls (IP) on 07787 278527)Finally, please remember this: NO BUSINESS is worth losing your health, relationships, marriages or your children over. Act properly, take advice, get the problem sorted and then get on with your life. In a little while the stress will go and you can focus on other things that are more important.Want more information on liquidation? Get our new free 2023 Experts Complete Guide to Creditors Voluntary Liquidation that covers Bounce Back LoansWe are experts in liquidation, voluntary liquidation, administration, pre-pack administration, business rescue, corporate rescue and company rescue, we can help solve your problems but only if you talk to us. Call 0800 9700539 for help.or email us your worries at 

Worried Director What Will Happen To Me After Liquidation?

Notice of Intention To Appoint Administrators

A notice of intention to appoint administrators is when the company files a document to the court to outline that it intends to go into administration if a solution cannot be found to its immediate financial problems. It can be used as part of the pre-pack administration process as well as used to restructure a failing business to avoid its liquidation.

Notice of Intention To Appoint Administrators
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A winding up petition is a legal notice put forward to the court by a creditor. The creditor petitions to the court if they are owed more than £750 and it has not been paid for more than 21 days. The application, in effect, asks the court to liquidate the company as they believe the company is insolvent.

What Is A Winding Up Petition By HMRC or Other Creditor

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