A very common problem, created by accountants telling directors how to mitigate tax!
Efficient and correct in times of plenty for a company, this approach can really bite back when losses pile up and that's when the trouble starts.
Usually the company is making some good profits and the external /tax accountants advise directors /shareholders to mitigate tax by paying your directors a small salary and to 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. At the end of the year a "tallying" takes place. Of course under Self Assessment the individual receiving dividends must account for this income and pay tax the following year.
THEN something goes wrong!
Although the advice is generally sound, from a tax reduction perspective, when a company is performing well; it’s when things go wrong that directors /shareholders can end up with serious personal liability problems.
Having an overdrawn director’s current account is actually a breach of the Companies Act 1985. 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 the Revenue will tax you on a fairly penal rate if you do not, (S419 ICTA 1988).
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 pretty much insolvent. Questions need to be asked about viability too.
How to repay your overdrawn account
- Repay the debt you personally owe to the company.
- Offset any loans the directors have made to the company (this is called set off).
- Take 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!
- Make a lot of profits in future periods to offset it!
What happens in liquidation if we have overdrawn current accounts?
In liquidation the liquidator can demand that directors repay their overdrawn directors 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.
So you could lose your house if your directors’ current account is overdrawn and not recovered.