Understanding the implications of an overdrawn director's loan account

Many UK limited companies, from small businesses to larger firms, are managed by directors who commonly invest their own money in the enterprise.

As well as putting money into the business, directors can also withdraw funds, which are not categorised as salary or dividends. These transactions are recorded in a director’s loan account

This article will explore this type of company account, explaining what it is and how directors use it, as well as detailing what happens in the event of an overdrawn director’s loan account.

We’ll also explain how our expert team’s understanding of accounting technology can help keep your agency on the right track.

What is a director’s loan account?

A director’s loan account is a record of every payment into and withdrawal from a company by its director.

For someone who has never taken any money out of the business – aside from a salary or dividends – the account balance will be zero.

There may even be some credit if the company director has invested in the firm or used their own funds for expenses such as business mileage or to buy assets.

What happens if the director’s loan account is overdrawn?

This is where the complications can start. As with a standard bank account, a director’s loan account becomes overdrawn if the director takes out more money from the business than they were owed.

The company effectively becomes a lender to the director. This isn’t a problem initially, if you or your accountant keeps a close eye on transactions to and from the director’s loan account.

If the sum involved is less than £10,000, any money owed must be repaid or offset within 9 months of the limited company’s financial year to avoid any tax implications. end. If that happens, there will be no tax implications.

How can I reduce the balance of my overdrawn director’s loan account?

There are several straightforward ways to address overdrawn director’s loans. The simplest and most obvious response is to repay the outstanding amount from your own personal bank account.

But it’s not the only solution.

If the limited company has enough retained profits then a dividend can be declared. Rather than paying yourself the dividend in cash, it can be used to offset the amount owing on the overdrawn director’s loan account.

You can do the same for any monthly net salary payments owed to you by the company.

Does it matter how overdrawn the director’s loan account is?

Yes. If the loan account balance is more than £10,000 and no interest is charged by the company to the director, then it is regarded by HM Revenue & Customs (HMRC) as a beneficial loan.

Under this circumstance, a limited company director gains an advantage from what is essentially an interest free loan, unlike for example, one offered by a traditional bank.

The company must then submit a P11Db return and pay National Insurance at 13.8% on the full loan balance.

The director must also disclose this benefit on their self-assessment tax return and pay personal tax on this benefit too.

Please note, an interest charge, based on HMRC calculations and rates, can be paid personally by the director on a loan of more than £10,000. In this case, the above requirements no longer apply.

What if I have an overdrawn director’s loan account at the year-end?

More serious tax implications arise if the overdrawn director’s loan balance is not repaid within 9 months of the company’s financial year-end.

First of all, the company’s corporation tax return will need to disclose this balance. Next, the Section 455 (also known as the S455 tax charge), levied at 32.5% of the balance, must be paid to HMRC.

It’s important to understand the S455 will be imposed irrespective of any corporation tax levied. It will not matter if the company has made a profit or loss, will pay corporation tax or not: the charge on the overdrawn account will still stand.

The S445 is due 9 months after your company’s year-end accounting period. If the amount is not paid, the business will face a corporation tax penalty amounting to 32.5% of the loan.

Potential S445 refunds

A limited company with overdrawn loan accounts can reclaim an S455 payment once the overdrawn directors loan account is paid off.

Be aware that this process can take some time. HMRC says: “repayment of the S455 tax is deferred until 9 months after the end of the corporation tax accounting period in which the loan is repaid or reduced”.

Withdrawing funds after repaying the director’s loan account balance

A word of warning about withdrawing funds after having paid back an overdrawn director’s loan account.

If one or more company directors take out the same or similar amount of money, up to 30 days after the balance has been repaid, HMRC will take a dim view.

It will assume they did not intend to repay the overdrawn loan, and will be required to pay tax on the full loan amount.

Will HMRC monitor an overdrawn director loan account?

Absolutely. HMRC pays particular attention to director’s loan accounts which regularly become overdrawn.

Officials could come to the conclusion that an often overdrawn loan account is being paid as a salary, or there is a taxable benefit being gained, potentially opening the door to some serious income tax and National Insurance implications.

We can help organise your processes, keeping a close eye on director’s withdrawals to ensure the £10,000 threshold isn’t breached and any company money taken out is repaid in good time.

Ways of dealing with an overdrawn director’s loan account

It is always wise to repay an overdrawn director’s loan account before the company’s year-end or, failing that, within 9 months of the end of the accounting period in which it becomes overdrawn.

In a ‘close company’, which has fewer than five shareholders including the director, the loan can be written off and treated as a distribution of profits.

The amount should be reported on individual tax records and levied as employment income.

In cases where the limited company is insolvent, business owners can attempt to clear the director’s loan account by agreeing the balance as a dividend or bonus. However, this too can be fraught with problems when a director owes money.

Companies in liquidation

If the limited company experiences financial difficulty, enters liquidation and the director’s loan account can’t be repaid, an insolvency practitioner will be brought in.

They will analyse all business assets and transactions, while establishing how much the company owes and to whom. The appointed liquidator could then demand the director taking money personally repay the loan so the company’s creditors can be paid.

In addition, HMRC will consider any unpaid, interest free director’s loans as untaxed income which, of course, brings with it more National Insurance contributions complications.

A director that can’t raise funds after taking money from their company, could find their personal assets are at risk.

Things could worsen from the company director’s point of view. They may even face the prospect of personal bankruptcy as the licensed insolvency practitioner does all they can to satisfy creditors.

To avoid threats such as personal bankruptcy, it’s worth being fully aware of your personal liability and responsibilities as a director, especially the implications of breaching these duties if your company enters the liquidation process.

What happens if I never repay the overdrawn director’s loan account balance?

If the overdrawn director’s loan account is written off, either through the close company method or by voting it as a dividend or bonus, then the balance is, naturally, cleared.

However, if the limited company is in liquidation and has been served a winding up petition, an official receiver would then become involved in the situation.

The assessment process after a company enters liquidation includes scrutinising any overdrawn director’s loan accounts. In some cases, the limited company director personally could be accused of wrongful trading and/or misfeasance.

It goes without saying this would have serious consequences, including possible director disqualification for up to 15 years.

Avoiding overdrawn director’s loan accounts

Managed correctly and regarded purely as a short-term financial tool, a director’s loan account shouldn’t be a problem.

It’s important that all loans are properly recorded, with any over £10,000 approved by shareholders.

Plus, if they are repaid in full within 9 months and one day of the company year-end, there’s no tax liability.

Independent advice, backed by the latest technology

It can sometimes be difficult to keep an eye on all the numbers that are generated by your business, but that’s where our team comes in.

Our knowledge of the latest bookkeeping and accounting technology can put insights into your company assets at your fingertips, whenever you need them.

Of course, having a clear view of what’s coming in and out of your agency doesn’t just make completing the company tax return simpler – it’s in the broader company interest.

The financial support we provide will help to prevent directors having to dip into personal funds to pay back an excessive overdrawn loan amount, or the company from issuing an additional dividend.

We’ll help put in place processes that will keep your director’s loan account firmly in the black and your agency on track for sustainable growth.

Let’s get started

If you have questions or concerns about your director’s loan account, whether it’s overdrawn or not, get in touch today.

You can call us on 01372 708090, or use this contact form, and we’ll get back to you straight away.