A director’s loan account (DLA) can be a complex issue for some directors, especially where a company is insolvent. Withdrawing money from a company requires careful consideration as it is a separate legal entity, with complex tax implications and usually open to more scrutiny. It is unlike a sole trader and partnership business, where withdrawing money can be a fairly straightforward process.
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 expenses/assets, then 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 be overdrawn. As part of a company’s financial reporting a DLA will be recorded as an asset or a liability 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 or offset 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 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 when a business is progressing well, but then struggle to repay the company back 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 of a Company Voluntary Arrangement). In these circumstances the overdrawn loan account will become an asset of the company and the appointed liquidator or administrator would almost certainly pursue this, particularly if it is a considerable amount. Legal action can be taken against directors in order to recover funds, including going after personal assets.
It would be unrealistic to think a liquidator or administrator would write off a substantial overdrawn DLA, as this is money taken from the company that should be 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 will be 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 legitimately 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 relevant office holder in order to agree a settlement or payment plan – this would at least avoid the risk of formal recovery action.
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 firstname.lastname@example.org.
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