The Director’s Loan Account is a record of all the transactions between the director and the company.
There are three ways a Director’s Loan Account may be recorded. One, when the director doesn’t take any money out of the company aside from salary and dividends, the Director’s Loan Account will have zero balance. Two, when the director puts their funds into the company, the Director’s Loan Account will be in credit, and the company owes them money. Lastly, when the director takes money out of the company in the form of a loan, the Director’s Loan Account will be in debit, and the director owes the company money.
Other Inclusions in the Director’s Loan Account
In cases where a company is considered a “close company”—that is, a company has less than five shareholders or participants—It must record any payment made to a director’s family, friends, or any person related to them. Also, a director cannot even avoid formally borrowing money from the company by merely using another person who is related or connected to them.
What happens when the Director’s Loan Account is in debit?
It is an account in debit is not a problem for a company, as long as the loan is paid within nine months after the end of their accounting period. When the loan remains unpaid within those nine months, the Director’s Loan Account becomes overdrawn.
What is an Overdrawn Director’s Loan Account?
As mentioned in the previous section, an Overdrawn Director’s Loan Account is a Director’s Loan that hasn’t been repaid. When the Director’s Loan Account has become overdrawn, a company’s tax return must reflect the amount owed to them. They will have to pay corporation tax on the unsettled payment nine months after the end of the company’s accounting period.
Tax Implications of an Overdrawn Director’s Loan Account
If a director has an Overdrawn Director’s Loan Account, this means they owe the company money. The director has nine months to repay the loan once the accounting period is over.
When the director fails to settle this loan, the company will incur a corporation tax penalty of 32.5% of the loan. If the amount is more than £10,000, and the loan is interest-free, the HM Revenue & Customs (HMRC) will view this situation as a director taking out money from the company as income. Thus, there will be income tax implications for both the director and the company. The HMRC will also charge the company interest on the loan until the corporation tax collected on the director’s loan account has been repaid.
How an Overdrawn Director’s Loan Account Is Viewed During a Company’s Insolvency
During a company’s insolvent liquidation, a liquidator has a legal duty to collect back all the money that the company has loaned.
When the loan is of significant amount, and when the sale of a company’s assets is unable to cover the liquidation cost, a liquidator may view the ODLA as the money they can go after repaying the company’s creditors. A liquidator may also file legal action to recover the director’s loaned amount, which may put their assets at risk.
A director’s situation may also worsen if a creditor, or even the HRMC, forces the company into liquidation instead of them filing for voluntary company liquidation. An Official Receiver will be liquidating the company and closely looking at the Overdrawn Director’s Loan Account history. Circumstances like this may lead to accusations of wrongful trading and abusing authority and power, which can ban the director from having the same position in other companies for up to 15 years.
Written Off Overdrawn Director’s Loan Account
There are also cases when a company may choose to write off an Overdrawn Director’s Loan Account. This means that a company has to waive the loaned amount in writing formally and not just agree not to collect or to stop receiving the director’s outstanding loan balance.
The amount that’s written off is treated as a deemed dividend or dividend that was assumed to be a dividend for taxation purposes under the Income Tax Law. Because it is a deemed dividend, there is no requirement for a company to have available profits for distribution. Thus, they do not need to pay the written-off amount to all of their shareholders.
In the case of a written-off ODLA, the HMRC will argue that writing off a loan is under the definition of profit or emoluments from an office or employment. They will be seeking to collect Class 1 NIC from the company. In this case, the written-off loan amount will be included in the director’s self-assessment tax return on a specific box on the “additional information” pages. Therefore, the company will not be receiving corporation tax relief on the written-off loan amount.
There are also cases when an Overdrawn Director’s Loan is reduced for legitimate reasons. This happens if, for example, the director uses their funds to pay for assets bought for the company’s use. In a case like this, then it may entirely write off the Overdrawn Director’s Loan Account.
In the case of a close company, the Overdrawn Director’s Loan may be written off when the director is also a shareholder. The loan may then be treated as a distribution of profits. However, suppose the director is not a company shareholder. In that case, the outstanding amount will be taxed as employment income which must be included in the director’s own tax return with the “additional information” section.
Lastly, in the case of a company’s insolvent liquidation, the liquidator has a legal duty to go after all possible ways to raise money for them to pay creditors in part or in full. When this happens, a liquidator may still go after the director for the outstanding loan amount in the Overdrawn Director’s Loan Account even when the amount has been written off.
To conclude, every time a company loans money to a director, it is essential to keep an organized record of all business and financial transactions to ensure that the company pays the right taxes.
It is also essential for a director to be aware of the consequences of borrowing too much money from the company to the point that they will be unable to pay creditors, or that they are forced into liquidation, and a liquidator has to file legal action to settle the director’s debt to the company.
Annette Ferguson – Chartered Accountant and Certified Profit First Professional – can help you unlock financial strategies to improve the profitability of your business amidst an economic crisis. Seek out a professional’s opinion. You can also follow us on any of our social media channels.