Overdrawn director's loan account: what it means in an insolvency

What is an overdrawn director's loan account?

A director's loan account is overdrawn when a director owes money to their own company, having taken out more than they put in and more than is covered by salary or declared dividends. The overdrawn balance is a debt the director owes the company, and it becomes an asset of the company the moment the business runs into trouble.

Directors draw on the loan account for ordinary reasons: taking money out through the year against dividends that are voted later, covering a personal cost from the company account, or leaving expenses unpaid. While the company is solvent this is a routine bookkeeping matter. Once the company becomes insolvent, the overdrawn director's loan account stops being a private arrangement and turns into money the company, and its creditors, can pursue.

What happens to an overdrawn director's loan account when a company is insolvent?

When an insolvent company enters liquidation, the liquidator must treat an overdrawn director's loan account as a company asset and take reasonable steps to recover it for the benefit of creditors. The balance the director owes is collected in the same way as any other debt due to the company, because the liquidator's statutory duty is to realise assets for creditors under the Insolvency Act 1986.

This is why the loan account matters so much once a company is failing. In a creditors' voluntary liquidation the liquidator reviews the accounts, establishes the overdrawn figure, and asks the director to repay it. Where the director cannot repay in full, the liquidator can agree a repayment schedule or, in the right circumstances, a settlement. Knowing the number before you start, and how it will be dealt with, is the single most important part of preparing for a liquidation.

How does HMRC treat a written-off director's loan account?

HMRC operates a voluntary process that lets an insolvency practitioner notify it when a director's loan account, or part of one, is written off inside a corporate insolvency procedure. A loan is treated as written off for HMRC purposes when the company, acting through its insolvency practitioner, accepts that the balance will not be repaid and stops trying to collect it.

A write-off can relieve a director of the obligation to repay, but it carries tax consequences that catch many directors by surprise.

• It is taxable on the director personally. A written-off loan is normally treated as income in the director's hands and must be declared on their Self Assessment tax return for the year the write-off happens.
• Section 455 tax on the company. Where the company has already paid section 455 corporation tax on an unrepaid loan to a participator, part of that tax may be recoverable once the loan is written off, and the insolvency practitioner deals with this with HMRC.
• HMRC is now more likely to know. Because the insolvency practitioner notifies HMRC of the write-off, the matter is on record, the return is more likely to be looked at, and a formal enquiry can follow.
• Take advice before you file. If you have had, or are trying to agree, a loan account write-off, speak to your accountant before you submit your next tax return so the write-off is reported correctly.

How much of an overdrawn director's loan account do you have to repay?

A director is expected to repay the full overdrawn balance shown in the company's books, because that figure is a debt owed to the company and, in an insolvency, to its creditors. There is no fixed percentage: the amount is whatever the loan account records once the accounts are brought up to date, adjusted for any salary or dividends that were properly declared.

In practice the liquidator looks at what the director can realistically pay. The outcome usually falls into one of the routes below, and an experienced practitioner will tell you honestly which one fits your position before anything is decided.

Every case turns on the figures and the director's means. Talk to us before you assume the worst.

Can an overdrawn director's loan account be written off outside insolvency?

A solvent company can write off or waive a director's loan by formal decision of the company, but the write-off is still treated as income for the director and is subject to income tax and, in some cases, National Insurance. Writing a loan off is not a way to make it disappear without tax, and doing it while a company is heading towards insolvency can expose a director to a claim.

If the company is solvent and being wound down for other reasons, a members' voluntary liquidation is often the tidy, tax-aware way to close it and deal with any loan balance at the same time. If the company is insolvent, the loan cannot simply be waived to avoid repayment, because the liquidator answers to creditors, not to the director.

How do you avoid problems with an overdrawn director's loan account?

The reliable way to avoid an overdrawn loan account becoming a problem is to keep it under control while the company is solvent and to take advice early if the business starts to struggle. Directors who act before a creditor forces the issue almost always have more options than those who wait.

• Keep the loan account up to date and repay drawings in good time, rather than letting the balance build across the year.
• Only take dividends the company can lawfully declare out of distributable profits, so drawings are not left sitting on the loan account.
• Watch for the warning signs of insolvency: pressure from HMRC, an unpayable Bounce Back Loan, or a threatened winding-up petition.
• Speak to a licensed insolvency practitioner as soon as the company's future is in doubt, so the loan account is dealt with as part of a plan rather than a surprise.

Why speak to NTF about an overdrawn director's loan account?

NTF Corporate Solutions is a boutique insolvency practice whose work is carried out by named practitioners, James Kaye and Nick Morgan, who are licensed by the Institute of Chartered Accountants in England and Wales. We explain exactly how an overdrawn loan account will be treated before you commit to anything, so there are no surprises later.

As part of the NTF group, we have helped company directors since 2009, we work in plain English, and the first conversation is free, confidential and without obligation. If your loan account is overdrawn and your company is under pressure, call us and we will tell you where you stand.