What is an overdrawn directors loan account?
If you’re a director of a company, you might be wondering what exactly an overdrawn directors loan account is and what are the rules and risks associated with using it. Essentially, it’s when the directors of a company have borrowed money from the company itself and have not yet repaid it. This can happen for a variety of reasons, but often it’s because the directors have used company funds for personal expenses. As a result, the directors owe money to the company, and the company’s financial situation is negatively affected. There is no problem with your company having an overdrawn directors loan account unless you are trying to close the company or have not paid it back within the allowed timeframes. As the director it is your responsibility to stay up-to-date with your filings and HMRC tax obligations. With careful planning and execution, you can get your company’s directors loan account to work for you and not against you.
The Benefits of an Overdrawn Directors Loan Account
- Access to More Capital
- Helps With Cash Flow
- Can Be Used for Personal Expenses
Having access to a Directors Loan Account gives business owners the ability to borrow money, as needed, which can make a huge difference when trying to run a company. Having ready access to this cash-flow allows you personally to make purchases and operate in a timely and friction-less manner. No need to fill in bank loan applications or meet with lenders. Quick access to funds in a no questions asked manner can be invaluable when building and growing your business.
The Risks of an Overdrawn Directors Loan Account
- Risk of Personal Liability
- Can Affect Your Credit Score
- Interest Charges
Managing an overdrawn directors loan account does come with the risk of personal liability & tax implications. If losses are incurred and not addressed, then the director who took the loan from the company can become personally liable for the overdrawn directors loan account. This can lead to creditors taking personal legal action against them to recover any losses and potentially losing their own assets in the process. The directors personal credit rating may subsequently be negatively affected moving forward.
This is due to the fact that an overdrawn directors loan is a personal loan from the company to the director. Should the company find itself in a position where it needs to close or creditors call in debts and the company is forced into LIQUIDATION then this outstanding loan will be highlighted and a settlement will need to be made on the outstanding amount.
Overdrawn directors’ loans also have a time limit for repayment and interest will be charged if the funds are not paid back within 9 months after the current accounting period ends. After this time the company will be charged a 32.5% corporation tax penalty on the loan amount. This extra fee can be claimed back from HMRC if the Directors’ loan account is paid back within 4 years. There are also HMRC tax considerations; should the loan be more than £10,000, this will involve both national insurance and income tax.
Reclaiming the extra corporation tax after the Directors’ loan has been paid off
You must claim it within 4 years.
As long as the overdrawn directors loan account is paid off within 2 years of the end of the accounting period that the loan was taken, then the company can simply reclaim that tax back through its corporation tax return when submitting accounts.
If it has been longer than two years then you will need to fill in a form L2P and either include it with your latest Company Tax Return or post it separately.
Further information can be found regarding Directors Loans on the UK Government website.
If a company director has an overdrawn director’s loan account it is likely that the liquidator will pursue the director to repay the loan. Many companies who were at one point making good money can easily end up in difficult situations that see liquidity dry up. Unfortunately for the director this means should the business find itself in liquidation proceedings then the liquidator will be looking to salvage funds from either company assets or any overdrawn directors loan. They will undertake personal insolvency procedures like sequestration against the director to recover this amount.
If the loan is small then there is a chance it will be looked at as not worth pursuing. However the liquidator knows this money can be recovered and the courts will support the recovery through personal sequestration so this is only likely to happen if the loan is very small.
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