A director’s loan account (DLA) is simply a record of transactions between the director and the company itself, outside of the normal salary, or dividends.
When a director takes more money out of the company than they put back in, the loan account becomes overdrawn. As the director’s loan account becomes overdrawn it is essentially classed as a company asset, due to the liability accrued.
What Causes an Overdrawn Directors Loan Account?
The most common situation that creates an overdrawn director’s loan account (sometimes called ‘negative directors loan’) is when a director takes advice from an accountant who tells them to take a minimum salary to keep National Insurance and tax at the lowest levels. The remainder of the remuneration is often then taken as dividends.
At first, everything works fine until something goes wrong with the cash-flow and the company runs into financial problems. The company may not be making the same profits as it was before, or may have to close due to unforeseen circumstances. Often the participators are unaware of their responsibilities during this period.
What Happens if you Don’t pay Back a Directors Loan?
You have 9 months to repay directors loans after the current accounting period comes to and end.
After that you will be charged corporation tax penalty of 32.5% of the loan amount.
Where the loan exceeds £10,000 there will be national insurance and income tax implications, since HMRC will conclude the director is using this money for salary.
Ultimately, if you cannot pay back the money you’ve withdrawn from your company, you may be forced into personal bankruptcy.
Can you Write off a Director’s Loan?
It is possible for ‘a close company’ (i.e. a company with fewer than 5 participators) to write-off a directors loan, assuming that director is also a participator.
In this situation, the director’s loan must be treated as a distribution of profits. If the recipient of the loan is not a participator, the outstanding amount must be taxed as employment income. The director would then have the responsibility to mention this on his/her individual tax return within the ‘additional information’ section.
In some cases there are legitimate reasons for being able to reduce any personal liability from a director’s loan, where expenses are due for mileage, assets bought for the company with your personal money and other expenses.
Overdrawn Director Loans during Liquidation
Although over 70% of all directors in the UK have owed their company money at some point, serious problems can arise from this if you are unable to repay the loan and the company becomes insolvent.
At this stage you should stop trading and seek professional insolvency advice, immediately.
In liquidation, the overdrawn directors loan becomes an asset which the insolvency practitioner will have a duty to try and realise on behalf of company creditors.
How Does the Insolvency Practitioner Recover the Overdrawn Loan Amount?
If your loan account is still outstanding at the point of liquidation, the Liquidator will seek to recover this debt for the benefit of the creditors. The Liquidator will need to bring the books and records of the company up to date and establish what monies were taken out by way of dividends, salary or as a loan. The Liquidator will need to ascertain your personal means. This could include the equity in your matrimonial home or other assets you may own.
Overdrawn DLA and Bankruptcy
In the worst case scenario, being unable to pay back the money you owe the company could result in your being forced into bankruptcy.
In addition, the insolvency practitioner will have a duty to investigate directorial conduct in the run up to the liquidation, meaning that, disqualification from holding the position of director is another possibility. This can last for up to 15 years.
Ultra Vires Dividends
If you have taken dividends from your company whilst it is insolvent, these dividends are known as Ultra Vires – meaning beyond your power, or authority. In other words, the director has paid him/herself in this way, when they should not have taken the company’s money. Mistakenly referred to as ‘illegal dividends’, they may be entered on the accounts as borrowed money from the company and it then becomes an asset for the business.
Key points on Director’s Loans
- You should not be taking dividends if your company is not making a profit.
- If your company is insolvent, you must avoid taking dividends, as this will add to any existing overdrawn director’s loan account.
- If your company is being forced into liquidation and you have an overdrawn director’s loan account then please speak with one of the team immediately for free and useful advice on your situation.
- There may be tax or interest implications for overdrawn loan accounts that have not been repaid within nine months of the company’s year-end.