Many are worrying that “they can’t repay their Directors Loan” and are wondering what solutions there might be.
If you are struggling to pay back your director’s loan accounts, then you may be stressed and overwhelmed by the problems this is causing for your company.
Directors’ loans are considered personal debts of the business director and also company debts backed with personal guarantees can be chased personally by any director who signs the financial agreement.
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Affected by Covid-19? You’re not alone, many businesses have become overdrawn due to limited cash flow.
Need business re-finance help or company closure advice? Then keep reading our article, as we will explain all there is to know about accessing help.
Table of Content
- 1 What Is A Director’s Loan Account?
- 2 When Do Overdrawn Director’s Loan Accounts Occur?
- 3 What are the Interest Rates on Overdrawn Director’s Loans?
- 4 Tax Implications of an Overdrawn Director’s Loan
- 5 Benefit in Kind on Director’s Loans
- 6 Do Director’s Loans Need To Be Paid Back?
- 7 Can A Director’s Loan Account Be Written Off?
- 8 What Happens To The Director’s Loan Account In Liquidation?
- 9 What Can Be Done About The Director’s Loans If The Company Goes Into Any Form Of Insolvency?
- 10 What if You Can’t Pay Off Your Overdrawn Director’s Loan Account?
- 11 Popular Questions
- 12 Summary
- 13 Struggling With Other Debts
What Is A Director’s Loan Account?
A director’s loan account is a log of the transactions between a company and the company’s directors.
The director’s loan account does not include any wage payments or dividends. It solely includes the funds that the director takes out to live on.
Any money taken from your company is a ‘drawing’, not a dividend.
As a company director, you can choose to pay into the company or to take money from your company.
If you add money to your company, then your director’s loan account is classed as ‘in credit’.
If the amount of money you have taken from your company exceeds the amount you have put in, then your account is deemed ‘overdrawn’.
As with any other debt, the overdue funds to your company will be seen as a company asset.
So, based on the size of the funds you have borrowed from your director’s loan account, there may be adverse tax implications.
Taking funding from your director’s loan account is legal and is common practice for most companies.
You should be conscious that if you can’t pay back an overdrawn director’s loan account, it is likely that you might encounter legal repercussions.
Especially if your company has been classified as insolvent.
When Do Overdrawn Director’s Loan Accounts Occur?
Overdrawn director’s loan accounts occur when the director takes out more money from their business than they put back in.
This tends to happen when the director’s income is funded by a low salary but is bolstered up by taking out frequent dividends, as a way of lowering tax costs.
Taking out dividends and drawings each month is usually standard business practice, however, issues arise when the company in question fails to make any profit.
One way of making sure your company doesn’t fall overdrawn in their director’s loan account is for the directors to frequently loan money back into the company bank account.
Adding enough money back into a loan account can help bring the overdrawn director’s loan account back to a clear credit.
Funding or loans can only be taken from a business that is solvent, meaning the company isn’t experiencing any financial difficulty.
If the company is facing financial difficulty and is likely to become insolvent, there may be legal consequences if you continue to take drawings or dividends.
For example, if you cannot pay back an overdrawn directors loan, then you may have to pay a corporation tax penalty.
What are the Interest Rates on Overdrawn Director’s Loans?
When the accounting period comes to an end, at the company’s year-end, then you will be given a total of nine months to pay back the outstanding director’s loan.
Once the nine months are over, if you still owe debts, then you will face unfavourable tax implications.
If your loan was taken out prior to 6th April 2016, your limited company may be forced to pay extra corporation tax of up to 32.5%.
If the loan was taken out before 6th April 2016, you will still have to pay an additional rate of 25%.
The additional corporation tax can make it difficult to repay your debts, so it is important to act sensibly when pulling funds from your company.
Make sure to only take drawings or dividends if you know your company makes sufficient profit.
Unaffordable company loans and company debts can force your business into liquidation.
Tax Implications of an Overdrawn Director’s Loan
Whether your firm has generated profits or losses or whether it has paid tax or not—the S455 tax charge on the overdrawn DLA is still due. It must be paid nine months after the conclusion of your company’s financial period, just as regular corporation tax.
This S455 tax is refundable if paid on time, i.e. nine months after your company’s fiscal year. However, HMRC states that “repayment of the S455 tax is deferred until nine months after the end of the company tax accounting period in which the loan is returned or reduced,” which can be a long and tortuous procedure.
Section 455 (Corporation Tax)
The corporation tax fee is otherwise known as Section 455 or S455.
If you can repay your company debts within nine months and one day, then you should be able to claim some tax relief.
Any interest that you might have paid, typically 3 to 4%, can not be claimed for.
It is very important that the balance of your director’s loan account is noted in your company accounts.
Your company tax return should provide full disclosure for any loans owed to your company.
Any leftover debts over the nine-month grace period will receive a charge of either 25% or 32.5%, dependent on when the loan was taken out.
Disclosure of loans is crucial, as Her Majesty’s Revenue and Customs (HMRC) can assess your director’s loan account at any time, as part of their Corporation tax compliance check procedures.
HMRC do this to ensure their own calculation are correct, however, failure to record any drawings could be seen as wrongful trading and you could be given a tax penalty.
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Benefit in Kind on Director’s Loans
In order to comply with tax regulations, the director’s salary should be taken through PAYE.
However, many directors choose to take their wages directly from the company as a way of lowering tax costs.
If you lend money from your company, you can enter a phase titled ‘benefit in kind’, which is when you are benefitting from funding that isn’t your salary.
There are various exceptions that allow you to avoid a ‘benefit in kind’:
- The amount of money you take is less than £10,000
- The company’s director is charged interest on the loan
- The director’s loan is taken out for business purposes e.g. partnership deals
Do Director’s Loans Need To Be Paid Back?
A director’s loan must be paid back, just the same as any other bank account loan.
If you wish to avoid any tax implications, you need to pay back an overdrawn director’s loan account debt within nine months of the accounting period ending.
If you fail to pay back the loan in the allocated time period, then you will face a corporation tax penalty of up to 32.5% of the total debts.
Can A Director’s Loan Account Be Written Off?
There are a few extenuating circumstances, under which an overdrawn directors loan account can be written off.
- Close Company – A company with fewer than 5 shareholders can write off a DLA, provided the director of the business is also a shareholder. In this case, the loan is classed as profit distribution, rather than a drawing. If the company money is distributed to someone who is not a participator, then the loan is taxed under employment income. So, the borrowed money is disclosed on the loaner’s tax returns.
- Legitimate reasons – For example, if the drawings are being used for expenses such as mileage or to purchase company assets, then the personal liability incited by the DLA can be minimised. Your national insurance payments may also be impacted.
- Dividend – The DLA can be minimised if the outstanding balance can be classed as a dividend. This will not work if your company is going into liquidation. It will only work if your company has no financial difficulty.
If you want to find out whether your DLA can be cleared, contact a debt advisor for independent advice and a free consultation.
What Happens To The Director’s Loan Account In Liquidation?
If your company falls into insolvency whilst having an overdrawn director’s loan account, this can be very difficult.
However, this issue is fairly common with roughly 70% of companies going through the liquidation process having an overdrawn DLA.
Should the company enter liquidation, the liquidator’s duty is to investigate the loan account and chase the debts.
Your personal assets may be deemed collateral, so make sure you always comply with the liquidator’s requests.
Legal action can be taken against the directors of a company to repay what their company owes. Unfortunately, this means the directors can be pushed into personal bankruptcy.
Always seek out professional advice for your finances as soon as you are aware that your company will have to enter liquidation.
Be aware that you could be penalised legally if you attempt to clear the balance of a DLA shortly before or during the insolvency procedures.
Speak with your insolvency practitioner if you have any concerns or queries about what you can or can’t do.
How Does the Insolvency Practitioner Recover the Overdrawn Loan Amount?
If you have an overdrawn director’s loan account at the stage of liquidation, the liquidator will try to recover any outstanding money owed, to pay back the creditors.
The liquidators or licensed insolvency practitioners will evaluate the personal funds of your company, through your accounting books.
Make sure your company’s money is kept up to date with any transactions, including salary payments, dividends, or loans.
The licensed insolvency practitioner will assess your personal assets, such as property, which may be held personally liable for immediate repayment.
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What Can Be Done About The Director’s Loans If The Company Goes Into Any Form Of Insolvency?
Once your company becomes insolvent and you still have overdrawn directors loan accounts, then they are a few options you have to repay the company money.
- Set up a repayment plan that will allow you to pay back the director’s loan account in full, over time.
- You can incite a set-off, whereby you offset any loan the directors have with the company.
- The directors can start taking a full salary, instead of having to pay dividends or drawings, meaning the directors pay tax.
- The limited company can attempt to increase their profits which would allow dividend payments and reduce company debt.
If you are struggling with limited company debt, get in touch with a professional debt advisory service straight away.
Free debt charities can offer confidential advice and help you find a suitable solution.
What if You Can’t Pay Off Your Overdrawn Director’s Loan Account?
If you cannot afford to pay back an overdrawn director’s loan account, then you may face personal bankruptcy.
Legal action may be taken to ensure directors loan accounts are repaid in full.
The licensed insolvency practitioners need to assess the conduct of the company director, to make sure there hasn’t been any misconduct.
If the liquidator finds any disingenuous conduct then the company directors can be disqualified from holding the position of director for any company, for up to fifteen years.
As soon as your company enters insolvency, it is important that your limited company stops trading.
Halting trading lowers the risk of your company entering any other credit agreements that they will find difficult to pay back.
If you continue trading you could be penalised for wrongful trading which could make you personally liable for the debts.
This is especially crucial to remember if you have acquired a winding-up petition, which is a legal order that forces an insolvent company into liquidation.
What happens if a directors loan account is overdrawn?
If a director’s loan account has become overdrawn your company tax return must reflect that by showing the amount owed.
The business will have to pay corporation tax on any amount that has not been repaid nine months after the end of your accounting period.
What happens if you dont pay back a directors loan?
If you don’t pay back a director’s loan you will be charged a corporation tax penalty of 32.5% of the loan amount.
You have up to 9 months to repay directors’ loans after the current accounting period comes to an end.
How do I clear my overdrawn directors loan?
Here are 5 ways to clear an overdrawn director’s loan account in most UK companies.
- Vote dividends to the Shareholder Directors
- Pay extra salary as a bonus to the Directors
- Ensure all expenses have been claimed
- Formally write off the Director’s Loan Account
- Use a combination of the dividends, salary, expense claims and writing off to clear the loan account
What does a negative balance on directors loan account mean?
A negative balance on a director’s loan account is when a director has taken more money out of a company than they have put in, not including dividends or salaries.
These overdrawn amounts are counted as assets on the balance sheets of the companies involved until they are repaid.
Can a directors loan account be in debit?
A director’s loan account can be in debit.
If the directors’ loan account is in debit, you owe your company money.
A DLA in credit means the company owes money to the director.
The safest way to ensure you don’t enter an overdrawn director’s loan account is to pay employees and the limited company director through PAYE, instead of drawings.
It can be dangerous to use drawings simply in the hope that the company can make enough monthly profit to pay out dividends.
It is important to pay tax, including income tax and corporation tax, to make sure you don’t run into any unseen tax implications down the line.
Remember that funds from any dividends must be disclosed on your tax self-assessment at the company’s year-end.
Should your company be made insolvent or be forced into liquidation whilst you have an overdrawn director’s loan accounting period, then you need to contact a debt help charity straight away.
Struggling With Other Debts
Here are some other debt guides if you are struggling with different types of debts:
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- Capital On Tap Business Debts
- Coronavirus Business Interruption Loan Debts Written Off
- Coronavirus Large Business Interruption Loan Scheme
- Directors Redundancy
- Funding Circle Debts
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