While directors’ loan accounts are permissible loans from a company to its directors, they can become thorny problems during annual tax returns or in cases of insolvency.
Many directors wish their company could simply write off the loans, but what are the laws around this?
An overdrawn director’s loan account (DLA) can be written off by the company. Here’s what you need to know:
To write off the loan, the company must formally declare that it will not collect the debt and document this.
Once written off, the amount is treated like a special kind of income for the director. It’s like receiving a dividend, but it doesn’t require the company to have made a profit.
HMRC will typically see this written-off loan as a type of salary. Therefore, the company will have to pay Class 1 National Insurance Contributions (NIC).
The director needs to mention the written-off amount when filling out their personal tax return. This will affect the tax the director has to pay.
The company won’t be able to reduce its corporation tax by the amount of the loan that has been written off.
It’s always worth using the services of a professional account to ensure the record keeping is accurate and lawful.
Disclosure of an Overdrawn Director’s Loan Account in the UK
In the UK, it is a legal requirement to disclose any overdrawn director’s loan account in the company’s annual financial statements. This requirement is set out in the Companies Act 2006.
The amount that the director owes to the company is generally listed in the balance sheet under “current liabilities.” If there is an agreement to pay back the loan after one year, it is listed as a “long-term liability” instead.
Additional information may also be necessary in the notes accompanying the financial statements. This can include details like the loan’s interest rate, repayment terms, and any guarantees that have been made.
Written off Directors’ Loans in Liquidation
When a company goes into liquidation, the insolvency practitioner (IP) is responsible for maximising creditors’ returns. As such, they will examine the company’s financial affairs in detail.
If the IP discovers a directors’ loan, even if it was formally written off in the previous accounting year, they will likely consider it an asset of the company that needs to be recovered for the benefit of creditors.
However, most IPs take a pragmatic approach to recovery. If you are unable to repay the full amount of the loan, they will usually be willing to reach a reasonable settlement. This is because the alternative would be to pursue bankruptcy proceedings against you, which is typically more expensive and time-consuming and may result in a smaller return for creditors.
Here are some additional things to keep in mind:
If you are a director of a company in financial difficulty, it is important to seek professional advice from a qualified accountant or insolvency practitioner such as ourselves. We can help you understand your options and minimise the risk of personal liability.
If you are unable to repay a directors’ loan, it is important to be transparent with the IP and cooperate with them. This will increase your chances of reaching a favourable settlement.
If bankruptcy proceedings are started against you, you will be disqualified from being a company director for a period of time.
