Dangers Of An Overdrawn Director Loan Account

This guide is for anyone concerned about the dangers of an overdrawn Director Loan Account.

Dangers Of An Overdrawn Director Loan Account Overview

When you are sailing profitably along the dangers of an overdrawn Director Loan Account can easily be overlooked. They can go beyond the elephant in the room.

What Is The Elephant In The Room?

An overdrawn loan account for a Director is an asset of a company. The Director owes the money to the company.

It might sit on the balance sheet for years. It might go up and down but the elephant in the room is that a day might come when it has to be repaid.

A Way Of Company Life

For many company Directors, an overdrawn Director’s Loan Account is like a way of company life. Money is drawn down during the course of the year and all being well via for example, a combination of a dividend and salary through some accounting entries it might be extinguished following your annual trip to see your financial adviser or tax agent.

When things start to go wrong for many companies that do not have the profits to pay dividends lawfully or there are insufficient funds to pay tax on salary, then the elephant in the room cannot be any longer ignored.

Liquidate With An Overdrawn Director Loan Account

Section 455 Tax

A choice may have to be made between the company paying the tax on an overdrawn Director’s Loan Account (known as Section 455 tax) or alternatively drawing a salary and paying PAYE / National Insurance on salary.

The rate of Section 455 tax is at 33.75% if the Director loan is not repaid within 9 months and one day of the year end.

Section 415 Tax

A danger for a Director personally is that if an overdrawn loan account is released or written off because it cannot be repaid then in view of Section 415 of the Income Tax (Trading and Other Income) Act 2005 the Director will have to pay income tax on the released sum.

Dangers Of Overdrawn Director Loan Account With An Insolvent Company

If a company is insolvent and unable to pay debts then the danger of an overdrawn Director’s Loan Account arising from payments to Directors (instead of drawings as salary) can be more severe.

A Liquidator would typically look to obtain repayment of the overdrawn amount if the company entered insolvent Liquidation.

According to Real Business Rescue[1] about 75% of Directors that have a company which goes into Liquidation have an overdrawn Director’s loan account.

An overdrawn loan account of a Director can sit on the balance sheet and inflate the net assets when there is no intention to repay it.

Below is a company that is just slightly balance sheet insolvent as of 31 March 2021 based on its balance sheet. However, if the overdrawn loan account is not going to be repaid then the company could potentially be more insolvent.

The danger is the overdrawn Director’s loan account might camouflage the true financial position of a company and it could be considered to be in better shape than it really happens to be.

If the overdrawn Loan account is more than the total balance sheet net assets then the Creditor Duty could kick in which could mean a Director might be vulnerable to claims in respect of other transactions in the event of insolvent Liquidation. This could amount to misfeasance and involve a Liquidator looking at how company funds were deployed to see if the Director is liable to account and compensate the company for any losses caused.

References

[1] Understanding Overdrawn Director’s Loan Accounts – Including Repayment, Interest & Tax