Overdrawn directors loan account
An overdrawn directors loan account (DLA) occurs when a director withdraws money from the company that is not classed as a dividend or salary, and the amount is greater than any money you have put into the company. Here, you are deemed to be benefiting from a director’s loan – a loan from the company to yourself. When unpaid, this loan is considered a company asset – this is very important, and will be addressed later. Having an overdrawn director’s loan account isn’t disastrous, especially if you or your accountant keep track of the money owed to the company and you can afford to repay it or offset it within nine months of your company’s year end. Problems arise when you’re unable to repay your director’s loan on time.
The ATO will view this as an interest-free loan that you are benefitting from and will expect you to pay income (personal) tax on what is classed as a ‘beneficial loan’. The benefit to you, in the eyes of the ATO, is the amount of interest you would have paid had you taken out a loan from a bank, called the authorised rate. Additional problems arise when an overdrawn director’s loan is still outstanding nine months after the company’s end of year accounting period. An overdrawn director’s loan account is not illegal; however, a director shouldn’t loan more than a certain amount from a company without approval from all shareholders (except where a sole director is the sole shareholder.
Overdrawn Directors Loan Account in liquidation – can it be written off?
Overdrawn directors loans can be problematic where a company is insolvent. This occurs when a director has taken money out of the business that is not classed as a dividend or salary, and the amount exceeds any money they have put into the firm. In insolvency, a liquidator will investigate whether the director’s loan account is overdrawn and if so, it would be considered a company asset that the liquidator would generally pursue, particularly if the balance was considerable. But can you ‘write off’ an overdrawn director’s loan account? Or are there ways to avoid having to repay it if you have experienced personal financial difficulties?
Writing off an overdrawn DLA
Ideally, directors clearly document the incomings and outgoings of their director’s loan account, and don’t allow it to spiral out of control. But when businesses face insolvency due to financial problems, the majority of cases will feature a director with an overdrawn DLA. Directors commonly ‘help themselves’ to company funds with the intention of paying it back eventually, only for the company to encounter financial problems. Revenue dries up, yet the loan is still outstanding – what now? The next step will depend on the value of the director’s loan, the amount the company owes to creditors, and whether or not the liquidator decides to pursue the director.
Even if the company has written off the loan, a liquidator could reverse this and request that the company director repay the overdrawn DLA. It’s a liquidator’s duty to scrutinise historical accounts and invoices and track money to ensure proper processes have been carried out. Actions can’t be taken just before the business goes into liquidation in order to avoid paying creditors. If the company was making a healthy profit but has fallen on hard times, potentially the director has drawn too much out of the company and is unable to repay it with the prospect of liquidation. Here, don’t expect the liquidator to write off the director’s loan account as it will be an asset of the company that can be used to pay creditors. Unless the director can repay the loan out of their own pocket, it is likely they will face a personal insolvency procedure such as bankruptcy.
There may be legitimate ways to reduce the amount owed to the company and thus reduce your personal liability – eg if you have reasonable expenses claims such as equipment bought for the company on your personal credit card, or business mileage and other expenses. This may reduce an overdrawn DLA, but may not alleviate the problem if the amount is significant. An overdrawn director’s loan account can occasionally be written off if the liquidator deems the value of the loan is insignificant. In an insolvency process, the director will normally square off their loan account in order to create funds for creditors; but if this figure is relatively small, the liquidator could decide that there are insufficient assets to carry through a formal liquidation process and, instead, look to have the company struck off the register.
Tax implications of an overdrawn director’s loan
A director can’t expect to take money from a company and avoid paying tax on it. The ATO will follow up overdrawn director’s loans. Even if your company is insolvent and is heading towards liquidation or has been served a winding-up petition, any untaxed income will be scrutinised and subject to a tax charge. The ATO won’t necessarily view your director’s loan as personal income because it is actually a company asset and owed to the business. Instead, they have specific rules that apply to individuals in these circumstances. This is separate to company tax; it makes no difference whether your business has made profits or losses or whether it has paid tax or not – this tax charge on the overdrawn DLA is still payable. It needs to be paid, as with standard company tax, nine months after the end of your company’s accounting period.
Possible problems for directors with an overdrawn DLA during insolvency
Significant problems can arise if a director has recently withdrawn company funds from an insolvent company. Sometimes a company will try to reduce the DLA by voting the balance as a dividend or bonus to clear the DLA. But if the company then goes into liquidation, this could be setting the company and director up for a massive fall. An experienced insolvency practitioner will scrutinise recent company activities including accounts and transactions and will investigate money trails. If it is discovered that creditors are missing out on amounts owed while a director has taken a huge dividend or bonus to clear an overdrawn director’s loan, legitimate claims could be made against the director including preferential treatment, transaction at undervalue, or plain breach of directors’ duties.
The director in question will need to prove that that particular dividend/bonus was in the best interests of the company and its creditors. However, this will be hard to justify to an insolvency practitioner or liquidator considering the company owes money that it now doesn’t seem to have. The director may be instructed to repay the overdrawn director’s loan amount back to the liquidator who will then use these funds to pay creditors. In insolvency, all creditors must be treated the same so a company bank account will be scrutinised for payments where someone, eg the director, received preferential treatment.
What if you cannot pay an overdrawn director’s loan account back?
Most directors in a liquidation process will have an overdrawn directors’ loan account. This money should be treated as a company asset, and assets will be the first thing a liquidator comes looking for in insolvency. When a limited company becomes insolvent, it should stop trading immediately. It may be unlawful to continue taking credit agreements with suppliers knowing that the company might not be able to pay them (however, recent Safe Harbour provisions allow breathing space for legitimate efforts to turn a business around). Directors may face serious personal implications. We are experts in this area, so contact us for a free consultation if you’re facing financial distress.
If you cannot repay your overdrawn loan back into the company, this may affect creditors. A liquidator will assess the amount of the overdrawn DLA and will look to realise funds in the best interest of creditors. The liquidator will look to recover this money, particularly where the overdrawn loan account and other assets are sufficient enough to cover the cost of recovery and provide a return to creditors. You should seek advice from one of our licensed insolvency practitioners at the earliest possible opportunity if this situation has arisen; we have offices around the country and a business turnaround specialist can speak with you at no cost and offer independent advice.
With an overdrawn director’s loan in insolvency, you should not be withdrawing bonuses or dividends from your company if it is not making a profit. This will add to an existing overdrawn directors’ loan account. If your company is heading towards liquidation, whether voluntary or not, and you currently have an overdrawn director’ loan account, then speak to one of our registered insolvency practitioners as soon as possible to understand your options and obligations.