A directors’ 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 from the company than has been placed back in, this is when the loan account becomes overdrawn.
As the directors’ loan account becomes overdrawn it is essentially classed as a company asset, due to the liability accrued.
How does an Overdrawn Directors’ Loan Account Happen?
The most common way 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.
As a director, if you loan money to your company, the directors’ loan account is in credit. This only applies if you have paid the money into the company bank account, but does not apply if you bought the company shares for example. If you have loaned your company money with interest, you must declare the interest as income on your Self Assessment.
If your company lends money to you, then your directors’ loan account is in debit or ‘overdrawn’. Remember, if you take money out of your company’s bank account, over and above money that you’ve loaned to the company – and that money is not a salary or a dividend; this can become an overdrawn directors’ loan account.
Are Director’s Loan’s Considered ‘Benefit in Kind’ ?
Where the director’s loan is greater than £5000 the the loan should be recorded, using director’s form P11D, as ‘benefit in kind’. However, when the director pays the correct rate of interest the benefit in kind need not be applied. For loans below £5000, there is no benefit in kind.
What are the Tax and Interest Implications for Overdrawn Directors’ Loan Accounts?
Once the accounting period finishes (year-end), you have nine months to repay the directors’ loan, after which, there may be some tax implications. the limited company will have to pay additional Corporation Tax of 32.5%. This stands for any loans taken out after 6 April 2016. For dates before this, the rate is 25%.
Section 455 (Corporation Tax)
This tax charge is known as Section 455 (S455), named after the section of the Corporation Tax Act which stipulates it. You may be able to claim for tax relief if the loan is repaid within 9 months and 1 day, however, any interest that was paid, which is between 3-4%, is not something that can be reclaimed. You can check the official rate of company interest for loans by going to the government website here.
If your directors’ loan account becomes overdrawn, it is important to prepare your company tax return to show the amounts owed and your company must pay tax on any amount you haven’t repaid prior to nine months after the end of your Corporation Tax accounting period. This will entail a charge of 25% corporation tax on the amount left unpaid.
Directors often overlook the fact that as a director of a company, you must manage any loan account very carefully, making sure you include all entries accurately and on time. Be aware that HMRC can, and often will, question you about any directors’ loan account as part of any Corporation Tax compliance check at any time, in order to ensure their calculations are accurate.
From 20th March 2013 several adjustments were introduced to the S455 tax charge to help prevent using close company loans to avoid tax.
What if my Directors’ Loan is less than £10,000?
One of the implications of an overdrawn directors’ loan account can come from what is known as a ‘benefit in kind’. This means that since the loan is effectively free of interest, you have a responsibility to repay it. An exception to this, however, occurs if the loan is small; for example, under £10,000 (previously £5,000). Any loan in excess of £10,000 must be approved by all of the shareholders.
Writing-off a Directors’ Loan Account?
It is possible for ‘a close company’ (ie a company with fewer than 5 participators) to write-off a directors’ loan, assuming that director is also a participator. In this situation, the 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 directors loan, where expenses are due for mileage, assets bought for the company with your personal money and other expenses.
Directors’ Loan Accounts and Insolvency
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.
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.
Winding up and Liquidation
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. Obviously, from the Liquidator’s perspective they will need to negotiate with you from an early stage as far as repayment is concerned.
The Liquidator will need to ascertain your personal means. This could include the equity in your matrimonial home or other assets you may own. They may require copies of your personal tax return and will consider the benefit to creditors and the extent to which any potential legal action could bring them.
There is no hard-rule, when it comes to directors’ loan accounts and the Liquidator, whilst ensuring that debts are recovered into the estate, will also need to make a commercial decision in accepting any offers made for repayment.
What are the Disclosure Requirements for Overdrawn Directors’ Loans?
Any existing directors’ loan account must be recorded in the company’s accounts, including the largest balance during the fiscal year.
Key points to remember about directors’ 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 directors’ loan account.
- If your company is being forced into liquidation and you have an overdrawn directors’ loan account then please speak with one of the team immediately to attain 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.