Although over 70% of all directors in the UK have an overdrawn director’s loan at some point or another, serious problems can arise from this if your company becomes insolvent.
If you have taken dividends from your company whilst the company is insolvent these dividends are known as Ultra Virus – meaning beyond your power, or authority. In other words the director has paid him/herself when they should not have. Commonly called illegal dividends, they may be entered on the accounts as borrowed money from the company. If you do not repay this money – it is essentially an offence from a tax perspective and this is known as an overdrawn directors loan account.
So how does the situation occur?
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 then taken as dividends. At first, everything works fine until something goes wrong with the cash-flow years later and the company runs into problems. The company may not be making the same profits as before or the company may have to close due to unforeseen circumstances.
What is the Interest on an Overdrawn Directors Loan Account
Once the accounting period finishes, you have nine months to pay back the loan after which 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%. This tax charge is known as S455, named after the section of the Corporation Tax Act which stipulates it.
What are the Disclosure Requirements for Overdrawn Director’s Loans?
The existence of any existing directors loans must be recorded in company accounts, including recording the largest balance during the fiscal year.
What if my Loan is for less than £5000
One of the implications of an overdrawn directors loan is known as ‘benefit in kind’ which means that, since the loan is effectively free of interest then you have a responsibility to pay that. An exception to this, however, occurs if the loan is small, ie under 10,000.
Can a Director’s Loan be written off?
It is possible for ‘a close company’ (ie a company with fewer than 5 participators) to write off a loan made to the director, assuming that director is also a participator. In this situation, the loan must be treated as a distribution. If the recipient of the loan is not a participator, the outstanding amount must be taxed as employable income. The director would then have the responsibility to mention this on his/her individual tax return within the ‘additional information’ section.
Director loan accounts in insolvency
If your account is still outstanding at the point of liquidation, the Liquidator will seek to recover this money 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 point of view 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 for example, the equity in your matrimonial home or other assets you may own, obtain copies of your personal tax return and consider the benefit to creditors and the extent to which any potential legal action could bring to creditors.
There is no hard rule, when it comes to director loan accounts and the Liquidator whilst ensuring that monies are recovered into the estate will also need to make a commercial decision in accepting any offers made for repayment.
Key points to remember:
- 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 an existing overdrawn directors’ loan account.
- If your company is being forced into liquidation and you have an overdrawn director’ loan account then please speak with one of the team immediately
Overdrawn DLA Tax Resonsibilities
If your director’s loan account becomes overdrawn then 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.
Directors often overlook the fact that as a director of a company, you must manage your directors’ 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 your directors’ loan account as part of any Corporation Tax compliance check at any time.
To be clear, if you, as a director, 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 your company lends money to you, 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, then this can become an overdrawn director’s loan account.