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Understanding Directors’ Loans: including what happens when it’s overdrawn

Directors’ loan accounts can appear to be a complex element of your business at first glance, but the basic concept behind them is straightforward – to provide transparency when moving monies between you, as a director, and the company.

A limited company is regarded as separate in law from its directors, meaning the two-way movement of funds is more complicated than for a sole trader. A director’s loan account can be in credit or overdrawn, but if it’s overdrawn the money must be paid back within nine months of the company’s financial year-end.

Failing to do this has tax implications for both the director and the company, with further ramifications should the business suffer financial distress, tells Keith Tully from leading corporate insolvency specialist Real Business Rescue.

What transactions might be recorded in your director’s loan account?

The initial investment you made in the business will be recorded here, as well as business expenses you’ve paid for with your own money, or assets purchased using personal funds – essentially any transaction other than salary and dividends.

The account is held within the company’s books, and if it remains in credit there is little to worry about. Only when it goes overdrawn could there be problems, and these range from tax issues to personal liability in an insolvent situation.

A two-way process

It’s often the case with a young company that the directors use their own monies to fund some of the ongoing expenses. In this case the loan account will be in credit, the company owes you money, and it will be recorded as a liability of the business on the balance sheet.

Conversely, you may have taken money out of the company in anticipation of dividend payments being approved. It’s not an uncommon scenario for trade to unexpectedly falter, however, bringing financial distress to a previously healthy company, and this can be when the problems of an overdrawn director’s loan account first arise.

When the account goes overdrawn

It is common for a director’s loan account to be overdrawn – a situation generally seen as part of the ebb and flow of business. If you’re able to repay the amount you owe to the company, everything will continue as normal.

It’s only when you fail to bring your loan account into credit again within the timescale provided, or don’t have the funds to repay what you owe, that issues arise. Directors must provide details of all directors’ loan accounts with their corporation tax return, including the current balance of each overdrawn account and the largest balance during the year.

You have nine months from your company’s financial year-end in which to pay back the loan. If you fail to repay, and the loan was more than £10,000, there will be tax implications for yourself in terms of receiving a taxable benefit, and also for your company.

Unfortunately, more serious ramifications could result if your company also suffers financial difficulties and enters insolvency.

Overdrawn and insolvent

A legal requirement exists for you, as a director, to place the interests of creditors first if you suspect the company is insolvent. In reality, this means being unable to recoup any money you’ve invested in the business, and if the company subsequently goes into liquidation, being pursued by the liquidator for the amount to which your account is overdrawn.

Even if the company has previously written off your loan, as the money owed is regarded as an asset of the company, the liquidator will take steps to ensure the amount is recovered for the benefit of creditors.

Depending on the size of the loan, repaying it could place considerable pressure on your personal finances, and in some cases has resulted in personal bankruptcy for the director involved. The ramifications of a failed business, therefore, potentially having no source of income and owing a large amount of money, are serious.

Furthermore, the liquidator will investigate the insolvency situation for instances of director misconduct, introducing the potential for disqualification and further financial penalties. Overdrawn directors’ loan accounts can become a major problem if not controlled effectively, but there are steps you can take to mitigate the risks.

What can you do to prevent the most serious consequences?

There are certain actions you can take whilst the company is trading successfully, to help avoid some of the problems associated with overdrawn directors’ loan accounts:

  • Paying off your loan in instalments – for example, only taking a proportion of your salary and paying the remainder to the loan account
  • Increasing sales, using the additional distributable profits to cover the payment of dividends and counterbalance the overdrawn account
  • Entering into a Company Voluntary Arrangement (CVA) if you’re eligible – this may allow you to repay the loan over a period of time

Avoiding personal liability is clearly a key factor here. By keeping a close eye on your director’s loan account throughout the year, you can take action quickly if necessary and control the likelihood of running into trouble.

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