Overview Of The Difference Between A Dividend And An Overdrawn Director’s Loan Account
The difference between a Dividend and an Overdrawn Director’s Loan Account is that a Dividend is a means of returning money to a company’s Shareholders whereas an Overdrawn Director’s Loan Account is a loan that a Director should repay.
In the hands of the recipient, once a Dividend has been declared the Shareholder is entitled to the money. Whereas a Director who has received loans from a company leaving them with an Overdrawn Director’s Loan Account is not entitled to keep this money.
Entitlement To Retain Company Monies By Dividend And An Overdrawn Director’s Loan Account
A Dividend is money a Shareholder should not have to repay except if it is an unlawful dividend or illegal because they are entitled to retain the money they have received. However, an Overdrawn Director’s Loan Account does not give rise usually (and is not intended) to enable the money to be retained permanently by the Director.
Any overlap between a Dividend and an Overdrawn Director’s Loan Account would only arise if the Shareholders and the Directors were the same people which is very common for most small medium owner managed companies.
What Is A Dividend?
A Dividend is a distribution of a company’s profits to its Shareholders.
When a Shareholder obtains shares in a company as an owner it typically does so in anticipation of a return on its investment. Shares are an asset or investment that a Shareholder is liable to pay for.
There are three ways in which a Shareholder can obtain a return on its investment in the shares of a company:
- Dividends which are taxed as income under the Income Tax provisions.
- Distributions which are taxed as capital under the Capital Gains Tax provisions. This will commonly arise on the winding up of a company by a Liquidator in a Members Voluntary Liquidation.
- The Shareholder can sell their shares to another party and make a capital gain on the sale.
A Dividend requires compliance with statutory procedures set out in the Companies Act 2006. It has to be declared with reference to relevant accounts (Section 836 of the Companies Act 2006) and there must be distributable reserves (Section 830 of the Companies Act 2006) otherwise it amounts to an illegal dividend.
What Is An Overdrawn Director’s Loan Account?
An Overdrawn Director’s Loan Account is a balance (or account) to be repaid by a Director who has received more money from a company than they are entitled to.
A Director is entitled to money from a company if they have unpaid salary, Dividends or made loans to a company.
An Overdrawn Director’s Loan Account is the opposite of a Director’s loan or monies a Director has spent to acquire goods and services on behalf of the company from their own personal money leaving the company owing the Director funds.
Is An Overdrawn Director’s Loan Account And A Dividend Different?
Yes, an Overdrawn Director’s Loan Account and a Dividend are very different because of the nature of the transactions. One is a loan to be repaid ie. the Overdrawn Director’s Loan Account and the other does not have to be repaid ie. the Dividend.
The connection between an Overdrawn Director’s Loan Account and a Dividend arises in an owner managed business where typically it may have been intended for monies a Director received from the company (which may have resulted in an Overdrawn Director’s Loan Account) to be cleared by declaring a Dividend.
However, when the accounts have been prepared the lack of available distributable profits may mean any Dividend would be unlawful thereby resulting in no Dividend being declared. As a result, the consequence may cause the realisation that the Director’s loan account with the company is overdrawn.
How An Overdrawn Director’s Loan Account Can Turn Into A Dividend
An Overdrawn Director’s Loan Account can turn into a Dividend if a company decides to write off the overdrawn balance on the Director’s loan account.
To be clear an an Overdrawn Director’s Loan Account is not illegal. A company may lawfully in accordance with Section 197 of the Companies Act 2006 lend money to a Director provided the loans are approved by the Shareholders. It is possible if this provision has been breached that this breach of duty can in any event potentially be ratified by subsequent approval via a resolution of the Shareholders in light of Section 239 of the Companies Act 2006.
When an Overdrawn Director’s Loan Account is written off by a Limited liability company then Section 415 Income Tax (Trading and Other Income) Act 2005 usually requires the relevant Director to be charged income tax on their personal self assessment tax return on the sum the company has released the Director from having to repay. The effect is to treat the written off sum as a Dividend, otherwise known as a Distribution.
