Can You Write Off An Overdrawn Director’s Loan Account?

Can You Write Off An Overdrawn Director’s Loan Account Overview

You can write off an overdrawn Director’s loan account. However, the consequence is the Director will pay tax on the amount written off when this is declared on their personal tax return.

If instead it is written off by a Liquidator then tax will still have to be paid by the Director personally.

What Is An Overdrawn Director’s Loan Account?

An overdrawn Director’s loan account is a sum of money owed by the Director personally to the company at any point in time. It is the opposite of a Director’s loan to a company and being in credit with a company that instead owes the Director money.

As the expression implies an overdrawn Director’s loan account arises when a Director has drawn out too much money from a company.

Owner managed companies by their nature will have a close relationship with their Directors whose personal financial success or failure is closely linked with the company. As a result, it is commonplace for a Director to withdraw money from a company to live off (typically through salary or dividends) and put money in to fund it when required such as by paying for some of its expenses. Sometimes a Director will also be lent money by a company. 

This inflow and outflow of money between the company and its Director creates a balance that can be in credit in favour of the Director or a sum owing by him or her to the company ie. the overdrawn Director’s loan account.

Writing Off Or Releasing A Director’s Loan Account

In the event a Director is overdrawn on their loan account then they are liable to repay it to the company. The company will pay Section 455 tax (33.75%) on the overdrawn amount if it is not repaid to the company within nine months of the year end. 

However, if a Director is unable to afford to repay their overdrawn Director’s loan account then one option might be for them to write it off. However, HMRC does not permit money to be received by a Director from a company in the form of earnings or dividends and for no tax to be paid on that by the individual. 

HMRC will typically treat the writing off of an overdrawn Director’s loan account as a dividend. In light 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 upon it being declared on their personal tax return.

However, some Directors may declare the written off balance on the Director loan account instead as earnings and obtain a corporation tax benefit. However, as a result, the company will be liable for National Insurance as well as having to deal with the PAYE on the Director’s earnings.

Disclosure Of An Overdrawn Director’s Loan Account

When a company has an overdrawn Director’s loan account this must be disclosed in its accounts and to HMRC in the Corporation Tax return by way of a supplemental sheet CT600A.

In the accounts, in light of Section 413 of the Companies Act 2006 the overdrawn Director’s loan account must be disclosed in the notes showing the amount advanced, any amounts repaid, written off or waived and details of any interest charged.

Disclosure to HMRC is in the Corporation Tax return supplemental sheet CT600A setting out details of the loan arrangements.

Is An Overdrawn Director’s Loan Account Illegal?

No, an overdrawn Director’s loan account is not illegal.

Although Section 197 of the Companies Act 2006 (“Section 197”) says that without shareholder approval a company cannot make a loan to a Director, there are two exceptions to this which means in most instances that loans to Directors are not unlawful:

1. Approval is not required under Section 197 if the amount is £10,000 or less in light of Section 207(1) of the Companies Act 2006.
2. Most companies are owner managed meaning that the Directors and Shareholders are the same people so the approval can in effect arise automatically. This follows the position in the Duomatic principle (“Duomatic”). Duomatic says if all Shareholders who have a right to attend and vote at a general meeting of a company agree that is as binding as a general meeting’s resolution.

Writing Off A Director’s Loan Account In A Liquidation

A company that is insolvent and therefore unable to pay its debts when they fall due which then ends up in Liquidation will be required to deal with an overdrawn Director’s loan account.

The Liquidator has a duty to realise the assets for the benefit of creditors. An overdrawn Director’s loan account represents an asset of the company. There is therefore no option for the Liquidator simply to write off the overdrawn Director’s loan account without proper justification and making some proper attempt to recover it. Failure to do so could mean a Liquidator could be considered in breach of their Liquidator duties, they could be considered negligent and they also could face regulatory consequences from their licensing body for failing to do their job properly and professionally.

One way to address matters is to negotiate a settlement with the Liquidator based on a Director’s ability to afford some repayments, often over a period of time rather than forcing them into Bankruptcy. Bankruptcy typically would produce a worse return for creditors and a Liquidator does have the ability to reach a commercial settlement. It is the duty of the Liquidator to maximise the returns to creditors of the company so normally it is perfectly possible for a deal on an overdrawn Director’s loan account to be done.

Assuming there is no dispute as to the amount outstanding to the company if a Director is unable to repay it either partially or in full to the company then the amount that will be released or written off will have to be declared by a Director on their personal tax return and treated as a distribution on which they will be liable to pay income tax in light of Section 415 of the Income Tax (Trading and Other Income) Act 2005.

Large Amount Of Equity In The Director’s Property

Many directors are (and should be) alert to the position that a company is a separate legal person to themselves as individuals. As a result, if the reason provided by the liquidator for not writing off the director’s loan is because a director has a large amount of equity in their property this can sometimes cause confusion.

If a director has a large amount of equity in their personal property it shows that they may have substantial assets to enable them to repay an overdrawn director’s loan account. It does not make the director personally liable for any of the company’s debts. The director has their own liability to the company in respect of their director’s loan account.

Liquidate With An Overdrawn Director’s Loan Account