If a company goes into liquidation the liquidator has a legal duty to pursue any viable option that could increase the repayment due to the company’s creditors. This will include a review of a Director’s Loan, even if it has previously written off.
What is a Directors Loan Account?
It is money that you as director borrow from your company and will eventually have to repay. It can also take the form of money a director lends to a company to help with start-up costs or to see it through cash flow difficulties. As such a Directors Loan Account is any transaction between the company directors and the company itself. Directors’ salaries, dividends and expenses are obviously recorded, but so too must any other monies paid to directors from the company and from the company to directors in the form of loan. So, if, as a director, you do not borrow money from your company or if you haven’t loaned your company any money your Directors Loan Account will be zero.
Using Your Directors Loan Account
It is perfectly fine to charge the company interest on the loan a director makes. The company will treat such interest as a business expense and will deduct any income tax at source. However, the company will pay no corporation tax on the loan. The director will need to declare any interest they charge on the loan as personal income.
A director may want to borrow from the company to cover one off expenses and so supplement salaries and dividends. The company may or may not charge the Director interest on this loan. The key thing to remember here is that if the interest is below the official rate the discount may well be considered as a ‘benefit in kind’ by the HRMC. As such the director may be taxed on the difference between any discounted rate and the rate set by the company.
A Director may borrow any amount from the company on the basis that there is consideration for the company’s cash flow needs. However, any loan over £10,000 will be treated as a ‘benefit in kind’ so the same HRMC rules as mentioned above will apply. It also important to note that any loan over this amount will need the approval of company shareholders.
So, how can an overdrawn director’s loan account be cleared in a owner-managed businesses
How can I clear an overdrawn director’s loan account?
There are a few options to consider and in short the answer is “Yes” you can.
In a “close company,” that is one with fewer than five shareholders and providing the director in question is also a shareholder, an overdrawn director’s loan account can be treated as a distribution of profits and written off. If the director is not a shareholder, the outstanding balance will be taxed as employment income and will need to be declared by that director.
Other options to consider include: –
Dividends To Clear The Director’s Loan Account
As a director you can vote a dividend provided the dividend is larger than the overdrawn balance then it will clear the overdrawn director’s loan account. The liability that arises will be a credit to the director’s loan account.
However, because dividends have strict rules to protect creditors, it is important that you ensure they are not unlawful dividends. A key question that needs to be asked is whether the company has sufficient distributable reserves.
It is also important to note that when assessing the ability to declare a dividend, the director has in mind that the company is not insolvent. If the company were to enter insolvent liquidation within 2 years of such a dividend, then it could be reclaimed by a liquidator as a preference. The reason why this is important to remember is that if the dividend is deemed unlawful or a preference, then it will have to be repaid.
Salary To Clear the Director’s Loan Account
In the same way as with dividends, you might be able to clear a director’s loan account by paying yourself extra salary as a bonus. However, this will be reported to HMRC under Real Time Information (“RTI”) that is provided to HMRC each month. PAYE and NIC will be payable on the salary, so the company should ensure that it has funds available to pay the tax. It’s important that the company aims to ensure that it is solvent and able to pay the tax as in a liquidation the liquidator might challenge the bonus payment as misfeasance and not in the best interests of the company.
Expenses Set-Off
If you have spent money on behalf of the company, provided you have retained evidence or can properly justify it (this is why your accountant insists on receipts) …. this could help you clear the director’s loan account.
Many directors incur expenses on behalf of a company but forget to claim them if they are considered trivial. Over time these mount up. However, you are entitled to claim them provided you are not claiming for periods when the accounts have already been filed and submitted to HMRC.
Writing Off
You can formally write off the balance due to the company. However, if you do this it will be treated as either dividends or salary depending on the structure of the company.
Repayment
The simplest step is to simply repay the money to the company. A Directors Loan must be paid back within nine-months and one day of the Company’s end of year accounting. If it is not there will be some heavy tax penalties. Any unpaid balance at that time will be subject to a 32.5 per cent corporation tax charge (the S455 tax). This can be claimed back, but it can be lengthy process. Also having an overdrawn Directors Loan Account whilst the company is insolvent has significant tax implications.
Key Considerations
- A Directors Loan Account needs to be carefully managed and even more so if it is overdrawn. There are numerous taxation issues, including penalty charges, which could arise if it is not.
- A Director may make a loan to a Company in the form of start-up capital or for the purchase of assets. If the Director charges interest this will need to be shown in their personal tax returns.
- A director may receive a loan from their own company if it is not in financial difficulty.
- Shareholder approval is required for loans over £10,000
- An overdrawn director’s current account that is not repaid is treated as an outstanding loan and this may create tax complications for both the company and its director.
- When a director has made a loan that is outstanding for more than nine months after the company’s accounting period end, the company will be required to pay tax under s.455 CTA 2010 at a tax rate of 32.5%.
- If the overdrawn (debit balance) on a director’s current account with the company exceeds £10,000 it is treated as an employment-related loan and it becomes a P11d benefit.
- Where a director makes a loan to a company that is written off a number of different tax consequences may well apply.
- HMRC will examine directors’ private expenditure during an enquiry into a close company’s books and records. In most cases, the company will be expected to produce a transaction history of any director’s loan or current account.
- Paying back a Directors Loan before the required time period only to borrow that amount again after the accounts have been submitted will we raise alarm bells. This so called ‘bed and breakfasting’ activity and is not looked favourably by HRMC.
- A Directors Loan Account needs to be carefully managed and even more so if it is overdrawn. There are numerous taxation issues, including penalty charges, which could arise if it is not.
- Subject to caveats you can combine dividends, salary, expense claims, some repayment, and some write-off element to clear your overdrawn director’s loan account.
If you are worried or have concerns about your business and would like to hold a free and confidential discussion, then do not hesitate to contact Lucas Ross – Business Rescue, Recovery & Insolvency on 0330 128 9489 or at help@lucasross.co.uk
