Overdrawn directors’ loan accounts can trigger significant tax liabilities and personal risks. Our experts explain the rules and potential consequences of an overdrawn directors’ loan account.
What is directors’ loan account and what is an overdrawn loan account?
Many directors will have a loan account with their company. Many of these directors are also shareholders of their company. Directors' loan accounts are commonly used by small and medium-sized businesses, allowing directors to access company funds for personal use during the financial year before reconciling the balance at the year end.
If the directors' loan account is overdrawn at the end of the financial year, the director will usually need to repay the company or declare the outstanding balance as salary or dividends and pay any tax due.
An overdrawn directors' loan account arises when a director has taken more money out of a limited company than they have paid in.
If the directors' loan account is in credit, the company owes the outstanding balance to the director.
Tax implications of an overdrawn directors' loan account
Key tax implications include:
Repayment deadline: If a directors' loan account is overdrawn at the end of the company's accounting period, the outstanding balance must usually be repaid within nine months and one day.
Section 455 tax: If the loan remains outstanding after this deadline, the company may become liable to pay Section 455 tax, currently charged at 33.75% of the outstanding balance.
Tax refund: If the director subsequently repays the loan, the company can generally claim a refund of the Section 455 tax paid, although this is not immediate and must be claimed from HMRC.
Benefit in kind: If the loan exceeds £10,000, it may be treated as a benefit in kind. The company may be required to report the loan and pay Class 1A National Insurance contributions.
HMRC
Directors will likely receive correspondence from HMRC in circumstances when a director’s loan has been written off or released, which in turn may mean that taxable income has been excluded from any income tax self-assessment return. Corporation tax has implications on director’s loans and it is important to seek legal advice to ensure these loans are correctly handled. In the event that a director is also a shareholder of the company, there are other rules which will come into play.
If you consider you have been treated unfairly you can request a review of a decision to impose tax, appeal the decision to the relevant tax tribunal or even pursue the matters through the courts. It is important to choose the right option and act quickly, as there are very short, hard deadlines for filing documents, and if you are out of time or make the wrong decision you may lose your chance to object even if you have a strong case. Our tax dispute specialists can help you navigate the options and act quickly to protect your position.
Our tax specialists can assist you with dealing with director loan accounts and disputes with HMRC.
Overdrawn directors’ loan accounts in insolvency situations
If a company becomes insolvent, the balance of an overdrawn directors' loan account is treated as a debt owed to the company. The overdrawn amount is treated as an asset. The administrator or liquidator will usually seek to recover the outstanding balance for the benefit of the company's creditors from the former directors of the company.
If a director’s conduct is found to have misused an overdrawn directors' loan account, for example by using it to withdraw what is effectively a salary without declaring it or paying the appropriate tax, a director could face director disqualification proceedings.
What happens if the debt cannot be repaid?
A director is personally liable for any debt incurred through a directors' loan account. As a result, if they are unable to repay an overdrawn balance, their home and other valuable assets may be at risk.
Depending on the circumstances, the director may face bankruptcy proceedings or need to enter into an Individual Voluntary Arrangement (IVA). They may also be subject to restrictions on acting as a director.
How we can help
If you need advice on loan accounts, letters received from HMRC concerning a dispute or decision to impose tax, and/or an overdrawn directors' loan account or are facing the risk of director disqualification, our specialist solicitors are here to help. Contact our specialist tax and insolvency or director disqualification solicitors for clear, practical advice tailored to your circumstances.
