Overdrawn Directors Loan Account

What is an Overdrawn Directors Loan Account?

Written by John A Waller, Director. Reviewed June 24th, 2024.

A director’s loan is when you (or a family member) obtain money from your company that is not:

  • a salary, dividend or expense repayment
  • money you’ve previously paid into or loaned the company

Records you must keep

As part of your financial responsibilities, the company must maintain a record of any funds you borrow from or contribute to the company. The ‘director’s loan account’ is essential to your company’s accounting records.

At the end of your company’s financial year

It is crucial to note that any outstanding loans, whether you owe the company or the company owes you, must be accurately reflected in the ‘balance sheet’ of your annual accounts. This ensures transparency and compliance with financial regulations.

An overdrawn directors’ credit account is an asset of a limited company until the loan is repaid, failing which the liquidator will request a refund in liquidation.

The director’s loan account shows transactions between the company and the directors.

The director uses his credit card or money to cover business costs. The company then owes money to the director. However, the amount credited to the director’s credit account will appear as a creditor until the director returns. (That is, the company owes the director). Suppose the director uses money or a credit or debit card from the company. Then, every payment is debited to his credit account, and he will be a debtor to the company until the credits appear to reduce or even repay the balance. (Here, the director owes money to the company).

Overdrawn director’s loan accounts cannot be written off.

Important points to remember about Director’s Loans:-

  • You may only vote yourself a dividend if you are a shareholder;
  • Understand where you show the amount owed;
  • Declaring it on your company’s tax return on the company’s year-end;
  • If your company operates at a loss, you must not draw down any dividends;
  • Do not draw dividends if your company is insolvent and still trades;
  • If your director’s account remains overdrawn, it is essential to deal with it, as it will not disappear;
  • Ensure you repay your loan within nine months or face interest and additional income tax;
  • Once refunded, ensure you show it in the company’s records.

IMMEDIATE HELP FOR DIRECTOR’S LOANS IS AVAILABLE TODAY!

Overdrawn Director’s Loan Accounts. When do they occur?

Commonly, the overdrawn director’s loan account arises from company directors seeking advice from the accountant to save tax.

However, the account commences once directors cease to take a full salary from their business and take a dividend instead. Therefore, they usually take a wage of £12,000 through the PAYE scheme and the top-up in dividends. The latter attracts a lower personal tax rate than through PAYE.

It is essential to understand how dividends remain paid and, importantly, to whom.

Dividends derive from distributable reserves within the business. But if the company runs out of money and the director still takes money out of business, they eventually become overdrawn, as with a bank account.

A simple equation that is controversial with business directors is when the company fails and goes into liquidation.

Note: If the company has no cash, it can’t pay dividends. Therefore, should your limited company’s balance sheet start with nil or negative reserves, and the business produces no profits or loss, then no dividends are payable. Accordingly, directors must cease drawing money until the company profits, rebuilding reserves to draw dividends. 

Directors shouldn’t draw drawings if they don’t draw dividends. However, if you take out a loan, you must repay it. 

Directors must understand the meaning and consequences of unlawful dividends.

Suppose your company goes into liquidation. Blaming your accountant still holds directors liable for incorrect monies from the company.

In detail then:

So, suppose the director loans the company money. In that case, it can be offset against the director’s account, either by reducing or paying off the amount owed, leaving the company owing money to the director, who now assumes the position of a creditor. For accounting purposes, transactions of this type must be made through the company’s bank account.

Company directors can borrow money from a limited company. However, the company must be solvent for the foreseeable future, as governed by the Companies Act 2006, as detailed in the company’s articles of association. 

Directors must first obtain shareholder approval to draw down loans up to £50,000.

Going Overdrawn

Directors’ credit accounts attract scrutiny from a few people, including the individual and the company itself, for taxation.

It’s important to remember that taking loans from a limited company differs from trading as a sole trader or partnership.

A limited company is a separate entity.

Once a director’s account remains overdrawn, the director is responsible for repaying the company.

The liquidator will return the money if the company goes bust and the director’s account remains overdrawn.

How long do I have to repay a Director’s Loan?

Directors’ loans should be returned within nine months of the company’s financial year’s end so they are not considered “overdrawn.”

Records You’re Required To Maintain

Directors should keep accounts current and track the money they borrow or pay into your company. This account is called the “director’s loan account.”

What if my Director’s Loan is below £10,000? – Income Tax Implications of an overdrawn director’s loan

HMRC can consider a director loan a benefit in kind, attracting a tax liability for the borrower.

However, an exception applies for a small loan, i.e., less than £10,000. A loan from the company exceeding £10,000 requires the approval of the company’s shareholders.

Paying Dividends While the Company is Insolvent

Paying yourself a dividend from your company while insolvent means the payments remain ultra-virus once the company liquidates. i.e. you had no authority to make such payments.

Mistakingly referred to as ‘illegal dividends,’ directors may enter into the accounts as borrowed money from the company, which becomes an asset of the limited company.

Disclosure 

Having an overdrawn loan account of a director means revealing the overdrawn amount in your company’s tax return. However, your company remains liable for any tax on monies not repaid before nine months after your accounting year-end for corporation tax. This will then mean the company will pay 25% corporation tax on the amount unpaid.

Directors often ignore managing their loan accounts. However, directors must ensure they include all entries correctly in the company’s records.

HMRC can inspect directors about their loan accounts at any time. They carry out such tasks based on Corporation Tax compliance inspections.

Tax Avoidance

Effective March 20th 2013, HMRC introduced several adjustments to the section S455 tax charge to help prevent closing company loans to avoid tax payments.

Your personal and business tax depends on whether the account of a director remains:

Ensure you understand the tax implications.

Interest Rates on Overdrawn Director’s Loans?

As soon as the accounting period finishes, you must repay any director loan within nine months of the year-end—failing; the company will incur an additional tax of 32.5% for the limited company.

However, it only applies to outstanding loans after April 6th, 2016

Average official rates per HMRC

Use the table below to find the average official rate of interest for years when:

  • The loan was outstanding throughout the Income Tax year;
  • You are using the standard averaging method of calculation.

Table of average official interest on the loan er HMRC

YearAverage official rate %
2018 to 20192.50
2017 to 2018.2.50
2016 to 2017.3.00
2015 to 2016.3.00
2014 to 2015.3.25
2010 to 2014.4.00
2009 to 2010.4.75
2008 to 2009.6.10
2007 to 2008.6.25
2002 to 2007.5.00
2001 to 2002.5.94
2000 to 2001.6.25
1999 to 2000.6.25
1998 to 1999.7.16
1997 to 1998.7.08
1996 to 1997.6.93
1995 to 1996.7.79

Directors Loan Accounts (OVERDRAWN) and in Liquidation.

An overdrawn director loan account refers to when a director owes money to the company (a company debtor). The liquidator will collect any overdrawn director loan account, as considered a debt owed to the company in liquidation.

Accountants advise directors, especially shareholders, that the most tax-efficient way to pay themselves is by paying enough through the company payroll to cover National Insurance Contributions, then the balance as drawings. (This, though, requires profit to pay drawing on account of year-end dividends)

Company director’s drawings exist when directors take money from the company, not through the payroll, leading to the balance on the directors’ “credit account” being overdrawn. i.e. the director owes money back to the company.

The company accountant finalises the available profit at year-end and declares an annual dividend. Dividends require credit to the overdrawn directors’ loan account, which hopefully, along with other potential credits, clears the overdrawn balance and may show the director as a creditor of the company.

If the company has earned an insufficient profit to clear the directors’ account, the account is overdrawn, and they owe the company money. This presents a problem once a liquidator is appointed. Often, directors have either forgotten or are unable to repay the company.

Overdrawn Director’s loan account and Liquidator’s Duty To Collect

The liquidator has little or no movement in overdrawn directors’ “credit accounts” (but is then blamed for collecting them). Also, the liquidator collects all debts owed to the company as part of their duty. So, their accountants must advise directors to monitor the situation monthly. If profits fall, tax savings will no longer be a priority. So, if this is the case, the company’s payroll will reward the director if no profit exists.

If a company enters liquidation, a balance shows owing on the overdrawn directors’ loan account. The loan account is part of the company’s assets. Then, the liquidator has a statutory duty to realise it.

Insolvency Practitioners attempt to treat directors’ overdrawn accounts reasonably. However, the loan is an asset of the company, so the liquidator must ensure that it is repaid.

Perhaps the report has not been updated with what the director may have paid out on behalf of the company but not accounted for through a legitimate expense voucher.

The liquidator remains committed and ensures a financial reconciliation of the money in and out of the company’s bank account and accounts for transactions in the directors’ “credit account”. Liquidators ask directors for receipts and evidence to support any directors’ claims.

If correct and verified, these amounts can be deducted from the directors’ loan account, reducing the balance owed.

Any balance remaining requires an agreement with the liquidator to repay the loan account.

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