Director’s Loan Accounts (DLAs) commonly feature in small and medium-sized companies, especially where the director is also a shareholder. However, problems arise when a director borrows more from the company than they are entitled to, creating what’s known as an Overdrawn Director’s Loan Account. This situation can have serious tax, legal, and financial implications.
In this article, we’ll break down what an overdrawn DLA is, why it matters, and how to resolve or avoid it.
What is an overdrawn director’s loan account?
An overdrawn Director’s Loan Account occurs when a director owes money to their company. This typically happens when a director withdraws funds that are not classified as salary, dividends, or reimbursed expenses. These types of transactions must be recorded in the director’s loan account.
If the loan is not repaid or offset, usually through declared dividends or salaries, within nine months of the company’s financial year-end, the outstanding balance is taxed at 33.75%
The issue is particularly important because a limited company is a separate legal entity. Any funds withdrawn belong to the company, not the director, and must be accounted for appropriately. An overdrawn DLA an asset of the Company until it is repaid.
Examples of directors’ loans:
- Taking money from the company for personal use.
- The company is paying personal bills on behalf of the director.
- Repayment of loans previously made to the company by the director.
Tax implications of an overdrawn director’s loan account
If the loan remains outstanding nine months after the end of the company’s accounting period, the company becomes liable to pay what’s known as Section 455 (S455) tax. As of 2024, the S455 tax rate is 33.75% of the outstanding loan balance and must be paid by the company nine months and one day after the accounting period ends. This is a temporary tax charge applied by HMRC to discourage the use of company funds as interest-free personal loans to directors.
Importantly, this tax is reclaimable, but only once the loan has been fully repaid to the company. The repayment must be made either by the director directly or through other means such as dividends or salary. The refund process can take time, as HMRC will only release the funds nine months after it is repaid.
Therefore, the longer a director’s loan remains overdrawn, the greater the cash flow impact and administrative burden on the company due to these tax obligations.
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Writing off an overdrawn director’s loan account
Writing off an overdrawn Director’s Loan Account is not always straightforward, especially in the context of insolvency. Even if a company has previously written off the loan, an administrator or liquidator may review the transaction and has the authority to reverse the write-off. In such cases, the director could still be required to repay the outstanding amount.
In some situations, there may be legitimate ways to reduce the loan balance, such as offsetting personal payments made by the director on behalf of the company, particularly where personal guarantees have been called upon and paid to settle company liabilities.
When a company enters formal insolvency proceedings, the appointed officeholder may choose to write off the director’s loan after reviewing the company’s financial records and assessing the director’s ability to repay. However, it’s important to note that a loan write-off can result in a personal tax liability for the director, as HMRC may treat the written-off amount as income subject to tax.
Legal & financial risks of an overdrawn director’s loan account
While Director’s Loan Accounts can offer flexibility for company directors, an overdrawn balance carries several serious legal and financial risks that can affect both the director and the company.
Risk to solvency and personal liability
An overdrawn director’s loan is recorded as an asset on the company’s balance sheet, as it represents money owed back to the company by the director. In such a scenario, a liquidator or administrator will demand full repayment, regardless of the director’s financial circumstances.
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How to avoid or fix an overdrawn director’s loan account
Managing a Director’s Loan Account (DLA) effectively requires a proactive approach. If your account becomes overdrawn, there are several strategies to rectify the position and minimise tax or legal consequences. Here are the key methods directors can use to avoid or address an overdrawn DLA:
- Repay the loan promptly
The simplest and most effective solution is to repay the loan in full within nine months of the company’s accounting year-end. Doing so will help the company avoid the 33.75% Section 455 tax charge and maintain clean financial records.
Repayment can be made in a lump sum or through multiple payments, but it must be received by the company before the deadline to prevent the tax liability from arising. Clear documentation of the repayment is essential in case of HMRC scrutiny.
- Declare dividends
If the company has sufficient retained profits, it may declare dividends to the director-shareholders. These dividends can then be used to offset the overdrawn loan balance, reducing or eliminating the debt. However, it’s critical to ensure that dividends are:
- Legally declared from actual post-tax retained profits.
- Properly documented through board minutes and dividend vouchers.
Declaring dividends without sufficient profits, known as illegal or ultra vires dividends, can expose the company and directors to serious legal and financial risks, including personal liability for the amount received.
- Increase the director’s salary
Another option is to increase the director’s salary, using additional earnings to offset the overdrawn balance. This must be:
- Processed correctly through the company’s PAYE system.
- Subject to Income Tax and National Insurance contributions, increasing the overall tax burden for both the director and the company.
This method can be effective if planned in advance and budgeted for appropriately. However, it may not be the best route for directors aiming to minimise personal tax liability.
- Charge interest on the loan
If the loan exceeds £10,000 at any point during the year, it is classed as a benefit in kind unless interest is charged at or above HMRC’s official interest rate, which at 6 June 2025 is 33.75%. By charging interest on the loan:
- The benefit in kind can be avoided.
- The company must report the interest income appropriately in its financial statements.
- The director may need to report and pay tax on the interest received, depending on personal circumstances.
Charging interest may not reduce the loan balance itself, but it can help mitigate personal tax exposure and ensure compliance with HMRC rules.
Regardless of the method used, it’s important to keep clear records of all director-related financial transactions. Regular reviews of the DLA, particularly before the company’s year-end, allow time to correct any overdrawn balances and plan tax-efficient strategies in consultation with a qualified accountant.
Worried about an overdrawn director’s loan account?
If your company is struggling with unmanageable debts, decreased cashflow and you are worried about repaying an overdrawn director’s loan account then our specialist business rescue and insolvency team are here to help. Get in touch today, and we can assess your options and provide you with specific solutions for your situation.
