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Overdrawn Directors’ Loan Accounts in Insolvency Procedures

Introduction

A director’s loan account (DLA) can be a complex issue for some directors, especially where a company is or might become insolvent.  Drawing money from a company requires careful consideration as it is a separate legal entity, with complex tax implications and may become subject to close scrutiny in an insolvency situation.

A DLA is a record of the transactions between a company and its directors.  If money is invested into the company by a director or personal funds are used for company expenses or assets purchases, the account balance will likely be in credit. Aside from salary and dividends, when more money is taken out than put into the company, the directors loan account will become overdrawn.  As part of a company’s financial reporting a DLA will be recorded as a debtor or a creditor in the balance sheet.

In this article we explore the implications of overdrawn DLAs when a company enters an insolvency procedure.

Implications of an Overdrawn DLA

Having an overdrawn loan account isn’t an issue if a record is kept by the company’s accountant and it can be repaid within nine months of the company’s year-end.  Problems can arise if this isn’t repaid in time as there are tax implications; any untaxed income would be scrutinised by HMRC and subject to a tax charge against the company (known as a Section 455 charge).  In addition there would likely be a benefit in kind personal tax implication for the Director.  Director’s loan accounts are regularly monitored by HMRC which, with electronic submission of Tax Returns, is now a much easier process.

Overdrawn DLAs in Insolvency Procedures

In most circumstances the director’s loan account becomes overdrawn when directors take money out of the company as a loan or interim dividends when a business is progressing well, but then struggle to repay the company if the business gets into difficulty, or if there have been insufficient profits to declare a dividend for the full amount of the DLA.

The issue of an overdrawn loan account can become particularly problematic where a company ends up in an insolvency procedure (voluntary liquidation, compulsory liquidation, administration or a Company Voluntary Arrangement).  In these circumstances the overdrawn loan account will become a recoverable asset of the company and the appointed office holder will pursue this. Legal action can be taken against directors in order to recover funds, and ultimately a director could be made bankrupt if he fails to repay the DLA.

It would be unrealistic to think an office holder would write off a substantial overdrawn DLA, as this is money taken from the company that should have been used to repay creditors of the company.  Even if the company has written off the loan to the director prior to liquidation, this decision can be reversed, and it is the office holder’s duty to investigate the affairs of the company by reviewing company accounts, bank statements and invoices.

Advice for Directors with an Overdrawn DLA

Directors should seek to address their overdrawn DLA before the company enters into an insolvency procedure.  There may be legitimate ways to reduce or clear the amount owed.  For example directors may have expenses that haven’t been claimed or made purchases on behalf of the company using personal funds – these can all be used to reduce the amount of an overdrawn DLA.

Directors could also consider taking all of their remuneration via payroll, providing the wages are properly incurred and the quantum reasonable.  However in this scenario it is also important to ensure that the company pays across any PAYE/NI deductions.

Ultimately, should the company enter an insolvency procedure with an overdrawn DLA then the director should work proactively and constructively with the office holder in order to agree a settlement or payment plan – this would avoid the risk of formal recovery action.

Furthermore, when considering whether to bring disqualification proceedings, the Insolvency Service will take into account the amount of any overdrawn DLA compared to the extent of any unpaid company creditors.

In Summary

Overdrawn DLAs can be very problematic for directors if a company is insolvent and it is therefore advisable that they seek advice at the earliest opportunity.

If any client needs advice around an overdrawn director’s loan account, then Bridgewood can help. For more information, please don’t hesitate to contact me on 0115 871 2921 or by email aftab.zahoor@bridgewood.co.uk.

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