Director’s Loan Accounts Explained: What To Do If You’re OverdrawnMay 28, 2021
Director’s loan accounts are commonly used in business - and they're not about financing a holiday or new car with company profits!
Instead, there are two typical ways you might end up with a balance on the loan account:
- You loan cash to the business during tough trading times or where a capital injection is crucial to financing a project
- You are paid via a mixture of PAYE salary and dividends, and the director's loan account balance accumulates each month
We'll explore that second scenario a little further - but, in essence, if you are overdrawn on a director's loan account, you technically owe that money back to the business.
If there has been a blip in trading and you anticipate making sufficient profits next year to more than cover the loan account balance, all is well and good.
However, things get stickier if the company is facing more challenging scenarios or there is any doubt as to whether it will remain solvent.
Let's discuss the options and strategies you can adopt if you have an overdrawn director's loan account and need to identify the most effective way forward.
How does an overdrawn director's loan account occur?
The most common situation is that, as a director, you are paid in two ways:
- Partly through payroll, with the tax deducted at source. This salary is usually limited according to the National Insurance bands for the year, making your payments tax-efficient
- With the balance as dividends. However, a company can't pay dividends from the profit it hasn't earned yet. In that case, the business will usually make the payments each month and record them in the director's loan account
While the money has been remitted, it isn't technically a dividend. Therefore, it constitutes a short-term loan as a debit balance in the company's books. This means that you owe the business that value.
It will be 'repaid' through the declared dividends at year-end rather than requiring actual cash payment.
You can see how a problem arises if, at year-end, there isn't enough profit to cover the balance already paid to you through the director's loan account.
Can businesses write off director's loan account balances?
Now, if you've found yourself in this position, our first advice is not to panic.
This sort of loan balance is not illegal and is permitted by The Companies Act 2006.
If you're a sole owner, you have the authority to decide what payments you are allocated through the loan account.
For larger businesses, the shareholders should agree on any loan values over £10,000 made from the company to a director. However, that's typically agreed when the director's salary levels are set for the year ahead.
Legitimate ways to write off director's loan accounts
There are a few options that might make it possible to write off director's loan account balances:
- You have claims to make for expenses incurred on behalf of the business
- You are owed mileage or other reimbursements that haven't yet been made
- The business could write off the account value as a dividend or bonus. However, remember that this isn't always possible if the company is loss-making. Should an insolvency situation follow shortly after, the liquidator may decide to call the funds back to the business
When a business does come unstuck, and a liquidator is appointed, a lot depends on the available assets.
If there is a significant value on an overdrawn director's loan account, they would be obliged to call on this to be repaid to raise funds for creditors.
However, if the balance is small and there are no other assets to use in a formal liquidation process, they might decide to forgo that option and have the company struck off as an alternative measure.
What is the worst case scenario with an overdrawn director's loan account?
The worst-case scenario would be if you had a large overdrawn director's loan account, the company went into liquidation, and you couldn't pay back the balance.
In that circumstance, you might need to opt for a personal loan or liquidate other assets to repay the debt.
It's always worth seeking professional guidance from the Hudson Weir team before taking any drastic actions, though!
Can directors incur tax on a director’s loan account?
If you have an overdrawn balance and owe money to the business, it won't be long before HMRC takes note and decides to levy taxes on this loan value.
That happens since you won't be paying interest, and your income won't have been taxed through the PAYE system.
Companies must declare the beneficial interest on the loan through a P11D declaration, as an interest-free loan is a taxable benefit.
Even if the business is insolvent or in liquidation, your personal income tax is still pursued.
Tax on director's loan accounts works according to a specific set of rules. It isn't classed as income since it is still a company asset and a value owed to the business.
S455 taxes on overdrawn director’s loan accounts
Here's how it works:
- If you have an overdrawn balance nine months after year-end, at over £10,000, the business will be taxed through S455 to a rate of 32.5%
- Corporation tax remains separately chargeable
- The S455 tax falls due at the same time as corporation tax, i.e. nine months after year-end
- S455 tax paid on time is refundable. However, it can take up to nine months after the trading period when you repaid the loan to receive an HMRC repayment
As you can see, an overdrawn director’s loan account can be a tricky situation to manage.
A lot depends on the company's trading position and whether you have the means to repay the balance in full.
In either scenario, the first course of action is to get in touch with a qualified insolvency practitioner.
It remains essential to ensure any steps taken are fully compliant with HMRC and company law.
As such, seeking guidance will ensure you make the right decisions about whether to write off loan account balances or seek an alternative solution.
For more information, or advice on personal or company insolvency, contact us today - we'd be more than happy to help.