Directors’ loan accounts (DLAs) are accounts held within the books of a limited company. As the company is a separate entity in law from its directors, they are necessary to record the financial transactions between the two parties.
If directors withdraw money from the company that is not their salary, a dividend payment, or reimbursement for a business expense, and the amount exceeds their investment in the company, this is regarded as a loan.
Which transactions are recorded within a director’s loan account?
Entries recorded in a director’s loan account generally include the director’s original investment, any personal funds that have been used to purchase goods for the business, smaller expense items such as business travel or accommodation, and withdrawals made by the director that do not include the above.
In essence, if money taken from the company exceeds that which the director has put in, the withdrawal is classed as a loan, with tax and other implications to consider for both company and director.
What are the implications of an overdrawn director’s loan account?
- If the loan exceeds £10,000, shareholder approval is needed and directors must declare the loan on their personal tax return.
- Unless they have paid interest on the loan at the HMRC rate, it is treated as a benefit-in-kind.
- If the loan is not repaid within nine months and one day of the company’s accounting year-end, it will need to be declared on the organisation’s corporation tax return.
- Section 455 tax becomes due on the outstanding amount at a rate of 25% for loans taken out before 6th April 2016, and 32.5% for those taken on or after this date.
- This form of tax can be reclaimed by the company, however, after nine months of the accounting year-end in which repayment was made.
A major concern for directors, and a particular issue for many businesses, is that of insolvency. If the company experiences financial difficulties that cannot be overcome, and liquidation is the only option, an unpaid director’s loan account represents a serious problem for directors on a personal level.
What happens to an overdrawn DLA if the company is insolvent?
Should the business decline to the point of insolvency, any existing loans are regarded as assets to be recovered by the appointed insolvency practitioner. If liquidation is unavoidable, this means that directors will be required to repay the outstanding amount in full.
Even if the loan was previously written off by the company, it can be reinstated by the liquidator. They work in the best interests of creditors, and so must maximise creditor returns from the liquidation.
Clearly, this introduces a serious risk of personal bankruptcy for directors, if they do not have sufficient personal funds to repay the loan.
Insolvency Service investigations
The liquidator investigates the circumstances in which the loan was taken – whether there were sufficient funds to support it at the time, for example, and if taking the loan could have contributed to the company’s demise.
If this is found to be the case, directors could face allegations of misconduct and potential disqualification for up to 15 years, in addition to serious financial repercussions on a personal basis.
When a director’s loan account is overdrawn, the director is a debtor of the company – a situation which does not necessarily pose a problem for either party under normal trading circumstances.
The vagaries of business, however, mean that a degree of caution is required when operating an overdrawn director’s loan account. It helps to protect the interests of creditors and directors alike, and factors in the potential for personal bankruptcy running alongside business insolvency.
Written by David Tattersall from Handpicked Accountants – a website which helps business owners and company directors find a reputable and reliable accountant in their local area.