The best way to deal with an overdrawn directors loan account in my limited company

The best way to deal with an overdrawn directors loan account in my limited company

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Have you ever found yourself in a situation where you’ve created a directors loan account by taking funds from your limited company to cover personal expenses, but now there aren’t enough profits to declare a dividend and clear the debt?

This leaves you with a headache – an overdrawn director’s loan account . This guide delves into the world of directors loan accounts, exploring your options and the tax implications of each situation.

Understanding Director’s Loan Accounts

Imagine your Directors Loan Account (DLA) as a personal account within your limited company. When you withdraw money for personal use, the DLA goes into debit (overdrawn). Conversely, if you contribute funds to the company, declare dividends you dont take from tha company, the DLA reflects a credit balance.

Typical Debits

  • Any drawings you take from the business for personal use or that intend to reflect your salary and/or dividends. 
  • When you withdraw money from cash points without physical receipts
  • When your company purchases items on your behalf for personal use e.g. a personal holiday 

Typical Credits

  • When you transfer your personal money into the company bank account
  • When you declare dividends for your personal self-assessment tax return
  • The processing of your salary through payroll

When the DLA Is in Debit there are several tax implications

Corporation Tax

You have 9 months and 1 day after your company’s financial year-end to repay the overdrawn directors loan balance. If you don’t the company may incur additional Corporation Tax called s.455 tax. 

This is taxed at the same rate as the higher rate of dividend tax (2024/25 this is 33.75%).

However, this additional tax is repayable to the company by HMRC when the loan is repaid by the director. HMRC will refund it within 9 months after the end of the financial period in which the debt is cleared. 

Benefit in Kind (BIK)

As a director, you can be in debit by £10,000 (interest-free) without triggering any BIK.

Above this amount can be considered a benefit in kind. It should be recorded at the end of the tax year on a P11D. The company must also pay Class 1A National Insurance on this balance (2024/25 this is 13.8%).

1 Extra Step – Getting Shareholder Approval

Shareholder approval should be sought for loans greater than £10,000. You may also be a controlling shareholder so this shouldn’t be an issue for most small Uk businesses. 

What happens when my Directors Loan Account is overdrawn and I can’t have further Dividends

While it’s perfectly legal to take money from your company, problems arise when profits are insufficient to declare dividends. Dividends, the official way for owners to extract profits, are subject to corporation tax before reaching your pocket. This is known as a post-tax distribution to its shareholders (a form of profit extraction).

This can’t happen if the company doesn’t have any profits – as they can’t be extracted.

However, DLA withdrawals aren’t taxed as dividends (not necessarily at that point), creating a potential tax burden if left unaddressed. Let’s explore your options for tackling an overdrawn DLA:

1. Repay the Loan

The simplest solution is to repay the borrowed funds. This keeps your accounts clean and avoids potential tax issues. Here are some ways to achieve this:

  • Personal Funds: Injecting your own money into the company settles the DLA debt. This is straightforward but may impact your personal finances.
  • Increased Salary/Bonus: If your company allows, consider a pay rise or bonus to generate the necessary funds for repayment. Remember, this option incurs income tax and National Insurance contributions.
  • Asset Sale: Do you have personal assets you can sell to raise capital for repayment? Explore this avenue cautiously, ensuring the sale doesn’t create financial strain.

2. Write the loan off

If your company writes off your debt, as a shareholder and director, you’ll pay tax at a lower rate on a loan write-off compared with if you had taken a salary. For 2024/25 this is 33.75% Vs. 40% as a salary. 

There is also a small cash-flow advantage as the tax wouldn’t be payable until the 31 January following the tax year of the write-off. Repaying via payroll would mean all the tax would be payable the following month! 

At first, this may seem more tax efficient. 

But you could also be subject to a national insurance (NI) liability. This can be seen as a huge drawback to writing off the debt. 

This is because HMRC tends to view a loan write-off as earnings for NI purposes. If this was the case then writing off the debt would be a less tax-efficient strategy. 

The argument from HMRC is that the write-off is deemed as “remuneration or profit derived from an employment”. If you can show that the write-off was instead because of your position as a shareholder then NI won’t apply.

This can be a difficult argument to win, and there’s a better option as long as your company has accumulated profits (reserves) that exceed the debt you owe to it – declare a dividend sufficient to cover the debt. Instead of paying it to you, it’s credited against your debt to clear it (a credit to your DLA). 

The reason it may be overdrawn in the first place is because over the years, you would have taken more than you would have declared as dividends, so you need to declare more and not take anymore to balance this out.

Seeking Professional Advice

Remember, this guide offers a general overview. Consulting a Chartered Accountant specialising in small businesses would be worthwhile. They can assess your specific situation and plan ahead. 

Keeping Your DLA in Check: Closing Tips

  • Maintain Clear Records: Document all DLA transactions meticulously. This ensures transparency and keeps admin simple.
  • Regular Reviews: Schedule regular reviews of your DLA balance to identify potential overdrafts early and address them proactively.
  • Dividend Planning: Develop a dividend strategy that allows for both profit distribution and DLA management (our own tool is here to help you with this).

Conclusion

An overdrawn DLA can be a worry, but with the right approach, you can overcome this hurdle. By understanding your options, you can navigate this situation effectively, ensuring the continued success of your business.

Early action is key. Don’t let your DLA snowball into a bigger problem. 

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