During challenging times when a business experiences a decline in profits, it is possible that the funds borrowed by the director from the company as a "loaned dividend" may not be available for repayment. This causes the Director’s Loan Account (DLA) to become overdrawn.
This situation arises because the company's financial performance may not generate sufficient profits to fulfil the DLA repayment obligation. It is crucial for business owners to consider this risk when deciding to borrow against future dividends, as the ability to repay the loan is dependent on the company's profitability.
In situations where the directors loan account (DLA) is overdrawn, liquidators will pursue directors for personal payback, including additional costs, fees and interest.
A company director has the flexibility to set their own wage, subject to the company's financial capacity. However, it is common practice for individuals to choose a salary that is equal to or below the National Insurance (NI) threshold.
At the end of the financial year, dividends are usually declared. Nevertheless, a business owner has the option to borrow funds based on anticipated future dividends through a director's loan account. It's important to note that dividends can only be paid by a company using profits earned after the deduction of corporation tax.
A DLA may have a credit balance should salary or dividends be allocated to a director, but they do not draw payment. Non-take-up may be for various reasons such as, the company may be experiencing cash flow problems and decide not to take salary payments, but to credit the DLA instead for later draw down.
A DLA is only overdrawn if a director has taken more money out of the company than has been paid in and has not repaid this loan by 9 months after the company’s year-end. HMRC views this as an interest free loan, that the director is benefitting from. HMRC will expect the director to pay income tax on it if it isn’t repaid or offset within those 9 months.
It’s not illegal to have an overdrawn DLA, but a director shouldn’t take a loan of more than £10,000 from a company without the approval of all shareholders. (Though when there is a sole director in place this is a moot point). If the debt is in excess of £10,000, it will be viewed by HMRC as untaxed income. The business will be charged corporation tax, and directors will have to pay income tax and national insurance.
It gets messy when a company becomes insolvent. The amount loaned to the director is seen as an asset to the company.
✅ Keep detailed and accurate records about the activity within your director’s loan account,
✅ Where there is more than one director, keep individual records and keep a loan account for each director.
❌ Don’t let your overdrawn DLA spiral out of control, get advice quickly.
❌ Don’t use your DLA as a way of helping yourself to company funds. You are liable to pay it back within 9 months or face paying income tax, national insurance and corporation tax.
❌ Don’t write off the loan in your accounts. In insolvency, any liquidator worth their salt will reverse the transaction and make the director repay.
❌ Don’t vote the overdrawn balance as a bonus or dividend. The audit trails will be clear to see, and an Insolvency Practitioner may investigate for preferential treatment.
❌ Don’t blame the company’s accountant. It is the director’s responsibility to manage the DLA and to know what its position is.
The rules of running a DLA, and the tax implications of such, are complex. Directors should seek professional advice from their accountant and/or tax adviser.
If you’re experiencing financial distress in your business and need some help, please do get in contact with us for a no-cost initial and confidential conversation. Call us on 01202 237337.
We’re an experienced team with strong values. We like to understand your needs and ensure you have the best advice possible. We’re experts in all areas of insolvency; you can read more about us on our website here.
Our download guide is ideal for both accountants and business owners. You’ll get the benefits of our 30+ years experience in one easy to read guide.
Afterwards, you’ll not only gain a better understanding of the processes, but you’ll also discover how we’ve helped hundreds of companies and provided peace of mind to countless business owners.
