The vast majority of UK companies are owner managed small businesses. It is a common feature of these businesses for directors to, where necessary, lend money to their company. Directors may also receive loans (or what are considered to be loans by HMRC) from the business.
In these situations, HMRC requires there to be a formal record of transactions between the director and the company, known as a director loan account.
Problems arise where a director takes more money out of the company than they put back in.
An overdrawn director loan is also problematic if the company becomes insolvent. In that situation, on liquidation, the liquidator will likely pursue the director for repayment of the debt in the director loan account. Having an overdrawn loan account may make a director reluctant to accept the business is insolvent for this reason. This in turn can create bigger problems and risks for the director.
What Causes an Overdrawn Directors Loan Account?
The most common situation that creates an overdrawn director’s loan account is when a director seeks to take money out of a company in the most tax efficient way, typically a minimum salary to keep National Insurance and tax at the lowest levels and an amount as dividends but also perhaps a loan from the company.
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 an end. After that, if the loan has not been repaid the company will be charged a 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Ultimately, if you cannot pay back the money you’ve withdrawn from your company, you may be forced into personal bankruptcy.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 shareholders) to write-off a directors loan, assuming that the director with the loan is also a shareholder.
In this situation, the director’s loan will be treated as a distribution of profits. If the recipient of the loan is not a shareholder, the outstanding amount will be taxed as employment income. The director would then have the responsibility to record 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
If a company goes into liquidation, serious problems can arise for directors who are unable to repay their director’s loans
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. The appointed liquidator can pursue the directors through the courts if necessary, and even cause personal bankruptcy in some cases.
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.
Key Points on Overdrawn Director’s Loans
- You should not be taking money out of your company if it is not making a profit.
- If your company is insolvent, you must avoid taking money out of, as this will add to any existing overdrawn director’s loan account and may well constitute wrongful trading.
- 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.