Overdrawn Directors’ Loan Accounts

If you’re a director facing an overdrawn Director’s Loan Account (DLA), it’s crucial to act swiftly to avoid tax charges, legal issues and potential personal liability. An overdrawn DLA arises when a director withdraws more money from the company than they have repaid. In close companies, this can trigger a corporation tax charge under section 455 of the Corporation Tax Act 2010 if not handled correctly.

In some circumstances, loans to directors may also require shareholder approval under the Companies Act 2006. Fortunately, there are practical and lawful ways to address the issue if action is taken promptly.

At a Glance

• An overdrawn Director’s Loan Account (DLA) arises when a director withdraws more money from the company than they have repaid, meaning the director owes money to the company.
• In close companies, an overdrawn DLA can trigger a corporation tax charge under section 455 of the Corporation Tax Act 2010 if the loan remains outstanding 9 months and 1 day after the end of the company’s accounting period.
• The current s.455 tax rate is 33.75% for loans made on or after 6 April 2022, but the tax is repayable once the loan is cleared, released or written off.
• Loans to directors may require shareholder (member) approval under the Companies Act 2006 unless a statutory exemption applies, including where the aggregate amount does not exceed £10,000.
• If a director’s loan exceeds £10,000 at any point during the tax year and interest is charged below HMRC’s official rate, a benefit in kind may arise, leading to personal tax and employer National Insurance obligations.
• Overdrawn DLAs must be shown as assets in the company’s accounts, reflecting amounts owed by the director.
• Common ways to clear an overdrawn DLA include cash repayment, dividend offset (where sufficient distributable profits exist), or salary/bonus through PAYE, each with different tax consequences.
• Artificial repayment arrangements, such as bed-and-breakfasting, may be challenged under anti-avoidance rules.
• In insolvency, an overdrawn DLA is treated as a recoverable company asset, and a liquidator will usually seek repayment from the director.
• Failing to address an overdrawn DLA can lead to tax charges, interest, legal risk and potential personal liability, making early action and professional advice essential.

Understanding the Legal and Tax Implications

An overdrawn DLA can give rise to a corporation tax charge under section 455 of the Corporation Tax Act 2010 if the loan remains outstanding at the relevant deadline. For loans made on or after 6 April 2022, the charge applies at 33.75% and becomes payable 9 months and 1 day after the end of the company’s Corporation Tax accounting period. This tax is not permanent and can be reclaimed by the company once the loan is repaid, released or written off, although interest accrues on any unpaid s.455 liability.

Personal tax implications may also arise. Where a director’s loan exceeds £10,000 at any point during the tax year and interest is not charged at HMRC’s official rate, the loan may give rise to a taxable benefit in kind. In such cases, reporting obligations and income tax and National Insurance consequences can apply.

Practical Steps to Resolve an Overdrawn DLA

• Repayment Options:
  
  • Cash Repayment: Repaying the loan directly to the company is the simplest option and avoids additional tax complexity.
  • Dividend Offset: If you are a shareholder and the company has sufficient distributable profits, a dividend can be declared and set against the loan balance.
  • Salary or Bonus: Additional remuneration can be processed through PAYE and used to clear the loan, although this will attract income tax and National Insurance.
    
• Shareholder Approval:

Certain loans to directors require prior approval by the company’s members under the Companies Act 2006, unless a statutory exemption applies. 

One key exemption applies where the aggregate amount of loans does not exceed £10,000. Directors should ensure that appropriate approvals are obtained where required.

• Avoiding Common Pitfalls:
  
  • Avoid “bed-and-breakfasting”, where a loan is repaid shortly before the deadline and re-advanced soon after. Anti-avoidance rules may restrict relief in these circumstances.
  • Avoid writing off loans without proper authority, as this can result in adverse tax consequences and potential breaches of directors’ duties.
    
• Professional Guidance:

If repayment is not feasible or insolvency is a concern, professional advice should be sought promptly, particularly from a licensed insolvency practitioner or qualified tax adviser.

By understanding the implications and taking decisive action, directors can manage an overdrawn DLA effectively and reduce exposure to tax and legal risk.

Defining an Overdrawn Director’s Loan Account

A Director’s Loan Account (DLA) records financial transactions between a company and its director that are not salary, dividends or reimbursed expenses. The account becomes overdrawn when withdrawals exceed repayments, meaning the director owes money to the company.

This situation commonly arises where funds are taken as informal loans rather than through payroll or dividends, which have different tax treatments and legal requirements.

In closed companies, an overdrawn DLA may fall within the scope of section 455 of the Corporation Tax Act 2010, which applies to loans made to participants. If the loan is not cleared by the statutory deadline, additional tax liabilities may arise.

In the company’s statutory accounts, an overdrawn DLA is shown as an asset on the balance sheet, representing amounts receivable from the director. Accurate records and proper documentation are essential for compliance.

When and Why It Becomes a Concern

An overdrawn DLA becomes a significant concern when statutory deadlines or compliance requirements are missed. The key trigger point is 9 months and 1 day after the end of the company’s Corporation Tax accounting period. If the loan remains outstanding at that point, the company becomes liable to the section 455 tax charge.

HMRC may scrutinise DLAs where repayment patterns appear artificial or where loans are repeatedly taken and repaid. Anti-avoidance rules exist to counter arrangements designed solely to avoid the s.455 charge.

Some loans to directors may also require member approval under the Companies Act 2006. Failure to comply with these requirements can expose directors to legal risk, particularly if the company later enters insolvency.

Ignoring an overdrawn DLA can therefore lead to corporation tax charges, interest on unpaid tax, and increased legal and insolvency exposure.

Risks and Consequences for Directors

An overdrawn Director’s Loan Account can expose directors to personal risk, particularly where company law requirements are not followed or where the company becomes insolvent.

In insolvency, an overdrawn DLA is treated as a company asset. A liquidator is under a duty to seek repayment of the outstanding balance for the benefit of creditors. Directors may be required to repay the loan personally.

Failure to repay or cooperate can lead to further action, including misfeasance claims or director disqualification proceedings where conduct is considered unfit. Directors must also remain mindful of their duties under the Companies Act 2006, especially when the company is experiencing financial difficulty.

Tax Obligations and S.455 Charges

Section 455 of the Corporation Tax Act 2010 applies to loans made by close companies to participants. If a loan remains outstanding for 9 months and 1 day after the end of the accounting period, the company must pay a tax charge.

Key Points:

• Tax Rates:
  
  • 25% for loans made before 6 April 2016
  • 32.5% for loans made between 6 April 2016 and 5 April 2022
  • 33.75% for loans made on or after 6 April 2022
    
• Payment Deadline: 9 months and 1 day after the accounting period end
  
• Relief: The tax is repayable once the loan is repaid, released or written off, subject to HMRC rules
  

Example:

If a company lent £10,000 to a director in June 2016 and the loan remained outstanding at the deadline, the company would be required to pay £3,250 in s.455 tax. This amount could later be reclaimed once the loan is cleared.

Personal Tax on Benefit in Kind and Loan Write-Offs

Where a director’s loan exceeds £10,000 at any point during the tax year and interest is charged below HMRC’s official rate, the loan may give rise to a taxable benefit in kind. The benefit must be reported, and the director may be liable to income tax on the cash equivalent of the benefit. Employer National Insurance obligations may also arise.

If a loan is written off by a close company and the director is a participator, HMRC generally treats the amount written off as a distribution for tax purposes. This means it is typically taxed as dividend income rather than employment income, although the precise treatment depends on the facts.

Benefits and expenses must be reported by the statutory deadline, which is generally 6 July following the end of the tax year.

Clearing or Repaying the Overdrawn Account

An overdrawn DLA can be cleared in several legitimate ways. Cash repayment is the most straightforward and avoids additional tax complexity.

Using dividends can be effective where the company has sufficient distributable profits, as required by Part 23 of the Companies Act 2006. Dividends must be properly declared and supported by available profits to avoid being unlawful.

Clearing the balance through salary or bonus is another option, but this increases income tax and National Insurance liabilities and should be carefully planned.

Each method must be implemented correctly to avoid unintended tax or legal consequences.

Handling Overdrawn Accounts in Insolvency

When a company enters insolvency, an overdrawn Director’s Loan Account becomes a critical issue. The liquidator has a duty to pursue repayment of any outstanding loan balance for the benefit of creditors.

If the loan is ultimately written off, this may result in a personal tax charge for the director, depending on the circumstances. Writing off loans without proper authority may also raise concerns about directors’ duties and conduct.

Seeking professional advice early, before formal insolvency proceedings begin, can significantly reduce risk and limit personal exposure.

Common Pitfalls and How to Avoid Them

• Ignoring Approval Requirements: Some loans to directors require member approval unless a statutory exemption applies. Ensure compliance with the Companies Act 2006.
• Missing the Statutory Deadline: Failure to clear the loan by 9 months and 1 day after the accounting period ends triggers the s.455 tax charge.
• Artificial Repayment Arrangements: Short-term repayments followed by re-borrowing may be ineffective due to anti-avoidance rules.

Your Immediate Next Step

Start by confirming the current balance on your Director’s Loan Account and identifying when the company’s accounting period ends. Decide whether repayment, a lawful dividend, or professional advice is the most appropriate course of action.

Addressing an overdrawn DLA early helps avoid section 455 tax charges, reduces insolvency risk and ensures compliance with company law and HMRC requirements. If there is uncertainty or financial distress, professional advice is essential to protect both the company and the director.

FAQs