Perhaps one of the most common queries of a director of a small company will be what happens to an overdrawn director’s loan account in a liquidation?
It is natural for a company director who has been unable to clear a director’s loan account to worry about what will happen in the event of a liquidation and how a liquidator will address it.
It is an asset of the company and the liquidator has a duty to recover it as part of their role in maximising the returns for creditors. If necessary a liquidator may even have to consider taking legal proceedings against a director to recover it but usually, the matter is dealt with by agreement.
What Is An Overdrawn Director’s Loan Account?
An overdrawn director’s loan account is a running record of the transactions between a director and their company. All transactions regardless of nature between them form part of a ledger both ways when directors lend money to the company or have money lent to them by the company. It will also include all monies owed to them if they have an employment contract with the company and are owed wages and any dividends they have declared in their favour.
At any given point in time due to the requirement for directors to keep company records of which a director’s loan account is just another record, they should know the makeup of the balance they either owe to the company or are owed by the company.
An overdrawn director’s loan account is when the balance is in favour of the company because the director owes money to it. This is a very common position.
Insolvent Company And An Overdrawn Director’s Loan Account
When a company is insolvent, if a director is commonly remunerated by way of dividends, then the problem of an overdrawn director’s loan account may get worse.
Once a company is insolvent it often will be unable to declare dividends as it will not have sufficient distributable profits required due to the strict way dividends are declared. When insolvent a company may also struggle to pay a salaried bonus to a director due to the HMRC taxes involved of PAYE and National Insurance Contributions. The effect of that is when it is cash strapped, company monies a director takes out for example to live off and put food on their own table will default to an overdrawn director’s loan account.
HMRC Tax And An Overdrawn Director’s Loan Account
If an overdrawn director’s loan account is not repaid by a director within nine months and one day of the year in which it is taken then the company will be liable under Section 455 of the Corporation Taxes Act 2010 to pay tax on it. This tax can be recovered when and if the director repays it.
However, if a director cannot repay it then any amount that is later written off by a liquidator will be treated as an income distribution to the director personally. Income tax will be charged on the director personally under Section 415 of the Income Tax (Trading and Other Income) Act 2005.
Liquidation’s Effect On An Overdrawn Director’s Loan Account
An overdrawn director’s loan account is therefore not written off as a consequence of liquidation or without consequences for the director personally.
Although a limited liability company may usually shield a director from liability absent fraud, breach of duty and neglect it does not give them a windfall to avoid repaying their debt due to the company.
Liquidation is not a process of wiping away a company’s assets; it is a process to enable them to be realised. Liquidation will crystallise an overdrawn director’s loan account.
