Directors Loan Account [2024 Guide]

What is a Directors Loan Account?

A director’s loan account is a record of loans made to or from directors of limited companies or a limited liability partnerships (“LLPs”).   The rules for LLPs are very similar to that of limited companies.

• Many companies are owned and managed by the same individual directors and this can give rise to a number of concerns such as possible manipulation to disguise unlawful drawings and remuneration paid to those directors.  

• As such, directors need to be aware of what is going on in the company’s finances when it comes to a director’s loan account – as otherwise there are personal risks which could follow is a director loan account has been abused.

• The risk of drawing money from a company and not accounting for it can have severe personal impacts at a later date for directors of limited companies and LLPs in the UK.  Our specialist team can help advise on these risks.

The rights to a director loan

Section 197 of the Companies Act 2006 (as amended) provides rights for directors loans to be advanced to a director.

• conventionally any director borrowing money in this way from a company will require the approval of its shareholders.
• This requirement and the approval itself will be subject to the company’s articles of association, which normally provide that directors can loan up to £10,000 without seeking such approval. However, this varies from company to company.

Debit or Credit?

A directors loan account can either be in debit or in credit.

When it is in debit, this means that the directors owe the company the balance of directors’ loan account and they are effectively a debtor of the company.

• Quite often directors loans are drawn during the financial year of the company and then, at the end of the financial year, set off against dividends declared as a result of profits drawn.
• This can be a tax efficient method of drawing remuneration from the company but there are considerable risks to take into account.   What happens if something affects the company and there is no profit?  This is something which may impact the director personally.  These are amongst the issues that directors need to pay attention to.

Alternatively, directors can loan the company money and this will be shown as a credit balance for a creditor in the company’s accounts.

How does a DLA differ to Loan capital?

As opposed to loan capital, a directors loans to the company benefits from being paid back earlier because they are just conventional debts of a company. The disadvantage of making such loans is that, in the event that the company is placed in insolvency or placed into an insolvent process, then the directors’ interest will be aligned with the interests of other unsecured creditors (and therefore may never be repaid).

There are alternate benefits to loan capital and unsecured loans by directors and we address this separately within our other webpages.

Helpful summary of key points relating to a Director loan account

1. Director borrowing from the company.

• If a director takes money from the company for personal use or any other reason not related to their salary or dividends, it is considered a loan from the company to the director.
• The amount borrowed is recorded as a debit in the director’s loan account. The director owes the company the money.

2. Director lending to the company.

• If a director lends money to the company, this amount is recorded as a credit in the director’s loan account.
• This scenario is less common, as directors typically invest in the company through share capital rather than lending directly.

3. Repayment of directors loan.

• If the director repays the loan to the company, the director’s loan account will be reduced by the repayment amount.
• The repayment is recorded as a debit entry in the director’s loan account.

4. Interest on directors loan

• If the company charges interest on the director’s loan, it needs to be accounted for in the director’s loan account.
• The interest charged should comply with HM Revenue & Customs (HMRC) guidelines, and it may be subject to tax.

5. Reporting to HMRC

• Transactions in the director’s loan account are reported to HMRC on the company’s annual accounts.
• The director may also be required to report any outstanding balance on their personal tax return.

6. Tax implications

• There are tax implications associated with director’s loans, especially if they are not repaid within certain timeframes.
• If a director’s loan account is overdrawn at the company’s financial year-end and is not repaid within nine months, the company may be subject to additional Corporation Tax.

It’s essential to maintain accurate records of the director’s loan account and comply with relevant regulations to ensure proper financial management and legal compliance. Consulting with our expert team can help make sure you navigate the complexities of director’s loan transactions and associated tax implications.

Directors Loan Account or Capital Investment?

When a company is set up it is usually set up with finance obtained either from the directors’ own resources or by formal investment funding.

Loans to a newly incorporated company (or even the company taken over or acquired) can be reflected either in the company’s reserves (or the LLPs partnership accounts) as a capital investment or alternatively as a loan to the company within the directors’ loan account.

Security for the director loan

Directors’ loan accounts very rarely seek security for their loan (although this may be available to protect such investment). 

• The reason usually being that this could otherwise deter investment sought from financial institutions or banks, who normally require that any advance to a company is secured by a first charge (with priority).
• However, even if director’s loans are secured, there are methods to enable a third party lender to take priority to the director’s secured interests (which may remain secured).

Directors loan account v capital investment

• The benefit of a directors’ loan is that HMRC will allow the director to charge interest.  Such interest can also be charged at a reasonably high rate and so directors will not be personally prejudiced by lending such sums (as long as the business does not fail).

• Benefit of recording a loan as loan capital investment within the reserves or capital account include
  • The impact upon any tax liability for capital gains on the company.  This is a particularly important consideration where an owner-manager’s strategy for the business is a sale.
  • Mitigation of the risks of a credit balance on the directors loan account.

Therefore, a director needs to think carefully about the amount of investment and the purpose of the company is, together with his/her long-term plans when initially setting up the business and investing funds into it.

Withdrawal of loans form the company – danger signs

A final consideration may be how such directors’ loans are later withdrawn from the company. As with all remuneration paid to directors, loans comprise an unsecured debt and where a company is facing insolvency or company rescue then directors should not simply withdraw any sums owed to them to get ahead of other creditors (particularly as they hold an advantage over other creditors in being able to control such repayments).

Directors loan accounts and dividends

Perhaps the most common use of a directors’ loan account is to draw funds from a company during the year.

• This enables a director to be paid in accordance with his/her requirements without having to account for any PAYE or personal tax returns due on such sums.
• As a repayable loan, a directors’ loan account does not normally need to be subject to any tax or otherwise and effectively is “free money” from the director’s perspective.

This is subject to the Section 455 Corporation Tax Act 2010 tax which we address in more detail later in this guide.

But conventionally this is how a lot of directors of SMEs in the UK operate and towards the end of the year, by drawing funds as a mix of expenses and remuneration and at the year-end the accountant will normally review the accounts, reconcile which are directors loans and which are a reimbursement of expenses and then reconcile the profit and loss account so that directors are informed as to the level of dividend they can recommend to shareholders.

• Subject to shareholders’ approval or variation of such recommendations, the dividend declared is then set off against the overdrawn directors loan account and any surplus paid to those same director-shareholders.

• Where directors are not shareholders, and any directors loan account balance is low, then the treatment is different and there is no charge to section 455 tax. 

Directors’ remuneration – how directors can be paid

Most commonly a director will loan money from the company during the financial year and then seek to recoup or set off such loan account balance (which is an overdrawn director’s loan account) by declaring a dividend at the year end.  

This offset can occur after the year-end (provided it is within 9 months) to avoid the section 455 tax charge which (if enforced) could undermine efforts to reduce costs for the company and its directors.

Distributable profits are essential

However, under the Companies Act 2006 and associated legislation, dividends can only be drawn on profits available for distribution. Such undistributable reserves include a revaluation reserve (where property assets may have been revalued) a shared premium account (where loan capital is advanced to set up the company) or the share capital account (which must remain in place by way of the principle of capital maintenance).

• For many companies, at least in the initial years following incorporation, distributable profits may not be generated.
• Distributable profits are the profits collated during a company’s trading cycle. For example, any profit made in the first year may be a distributable profit.
• If however a distributable profit arises in the second year but there was a loss in the first year, then the distributable profit is the net of the two.

The profit and loss reserve in the company’s accounts should always set out the balance of the distributable profit available for dividends to be distributed from. When looking at abbreviated accounts at Companies House, these distributable profits are often net of any dividends paid and the public will never usually know what dividends have been declared and paid by the company.

Void dividends

It is often the case that director shareholders are pursued for dividends drawn when no such distributable profits existed. A dividend drawn without distributable profits being available will be void ab initio and therefore are liable to be repaid to the company.

• There are of course principles of set off where a director can claim other sums due to him/her which may be set off from such a reclaim, but there are distinct rules which apply to such set off principles.
• The principle of mutuality provides that a director’s entitlement to set off expenses from any void dividends should not be capable of set off because the two transactions are with two different legal characters, one as the director and one as a shareholder.

Similarly, with directors seeking to claim for remuneration which has not been paid (which can come in various forms, as the lawyers will no doubt know) there is usually a requirement for evidence of the entitlement to such remuneration due from the company.

• The existence of contracts of employment, service level agreements or patterns of behaviour which reflect such entitlement are all factors to be considered when claiming the entitlement to such remuneration.
• It is well documented in the courts that a director cannot simply create an entitlement when challenged on dividends, as the court will focus solely on what the company and its directors’ intentions were at the time (usually as evidenced by the documentation available).
• However, there is a common law right to be remunerated for services provided and so this issue remains contentious.

It is therefore essential that directors seek advice and properly document their decision making to mitigate any risk to them that may arise in the future. The guidance from the government website on director loans makes the record keeping obligations very clear. These are part of wider director responsibilities for running a limited company.

Dividends v salaries

The question of how best to structure remuneration in a company is very important to get right. Otherwise there can be conflict between shareholders and directors – and possible claims by HMRC or liquidators should things go wrong. Our expert team can help.

• In a small owner managed company, where the directors and shareholders are the same individuals, the issue of being paid a salary becomes more contentious in light of the fact that (for higher earners) the tax liability due on a salary payments is incredibly high when compared to most small business taxes.
• For obvious reasons this can appear quite frustrating particularly where a director feels as if s/he is working for HMRC rather than for himself, with half of their hard-earned income (or more) being paid to the state.

Most companies will expend considerable effort on mitigating, or avoiding, this expensive tax expense but this can be dangerous where the necessary tax planning becomes avoidance, or a wilful attempt to avoid paying legitimate tax liabilities.

Disguised remuneration – beware of the risks

Alternate approaches to extracting income have been adopted by many individuals and their businesses in recent years using complex tax schemes in an effort to mitigate their exposure to income tax. This is often referred to as disguised remuneration.

These steps may disguise such income as loans or other payments out within small owner-managed companies, where the sole purpose is the evasion of tax.

However, this has become subject to rigorous tax legislation and the legal requirement for tax disclosure.

Director’s loans

A common practice within small companies, to negate the problem of high income taxes (via the PAYE/NIC system), was to take a director’s loan and then to draw income as dividends at the year-end (with lower tax rates) or find some mechanism to write them off at a later date.

• whilst this practice is legitimate, the common occurrence of this (and often the writing off of such loans) led to the introduction of taxes due on director’s loans, which could only be recovered if the loan was paid back.
• this loan charge provides quite a disincentive for director’s taking loans, where they had been accounting for such loans.

This can have severe consequences for directors of companies which may face a company rescue situation or insolvency proceedings, as effectively they are often required to pay back what they have otherwise received as income over the final trading period of the company.

Dividends

The more acceptable method for drawing income whilst mitigating taxes exists where the directors are also shareholders of the company, who can declare a dividend at the year-end and set this off against any outstanding director’s loan account balance. Tax on dividends can be more beneficial than normal salary rates.

• Quite commonly directors of a small company pay themselves a salary via the PAYE/NIC system either up to the limit of their tax-free allowance or up to the limit of the lower band for PAYE/NIC.
• A dividend of sums in excess of this carries a reduced tax rate, which is intended to encourage entrepreneurship and the growth of companies in the UK, but following changes in ongoing Budgets, the difference in recent years has become narrower.

Process of declaring and paying a dividend

Whilst it is a mandatory legal requirement for a company to have distributable accumulated profits before a dividend is declared and paid to its shareholders, the Companies Act 2006 requires that a specific process is adopted for declaring a dividend, to ensure the directors have considered all of the company’s financial information and have jointly agreed to declare such a dividend, and to ensure shareholders agree the payment.

If this process is not adopted, despite having distributable reserves available for this purpose, the dividend will be void and technically repayable by the shareholders and/or directors (if they are deemed to have breached their fiduciary duties).

Difficulties – and how we can help you

Where a company fails or does not make a profit, and loans have been made to directors (with the intention of setting off a dividend declared at the year-end), the director will have no entitlement to a dividend and may have to repay his/her director’s loan account or pay the taxes due on that loan account.

At Francis Wilks & Jones we are able to assist with any legal matters arising in respect of these problems, your potential defences to claims for repayment of such loan balances as a result of a claim by a liquidator or a claim for breaches of your fiduciary duties.

Income paid via directors loan accounts

How best to be remunerated as a director is very important. Our expert team can help whatever the issue.

In a small to medium sized business, it is often the case that a director is also a shareholder.

What is a director’s loan account?

When the business owners and the directors are the same, and the profits of the company are up and down over the year, but expected to end up in profit, rather than take a regular salary, or regularly declare dividends, it is common for director shareholders to take money from the company for living expenses over the course of the year, with the expectation of accounting for them in the accounts at the end of the year and meeting the tax requirements at that time. Monies taken in this way must be recorded in a Director’s Loan Account (DLA) to be properly reconciled at the end of the year.

• it is not illegal to take money from a company by way of a director’s loan account;
• a loan account can also be used by a director to lend money to the company, borrow money from the company that exceeds the amount put in by way of investment, or reclaim money that has previously been put into the company;
• the director’s loan account must, however, form part of the books and records, as this forms part of the company’s balance sheet on the annual accounts for a company showing monies in and out of the account;
• depending on how the money is accounted for, tax will need to be paid on these drawings – for more information see our page on abuse of a director’s loan account later in this guide.

If a director’s loan account is overdrawn at the end of the year, and is not accounted for, then there is a potential tax liability on this, either for the director, depending on the amount, and/or for the company – as set in more detail below.

Director’s salary via a director’s loan account

It is common that for practical reasons a small business will not declare dividends more than once or twice a year. Dividends must be declared by the company on profits once corporation tax has been paid by the company.

Directors who are also shareholders often will take their salary as a mix of dividends, and as salary under the PAYE and NIC scheme. The reason behind this is to take income in the most tax efficient way possible.

• if dividends are declared at the end of the year that are equal to a director’s loan account taken by way of income throughout the year by the director, then the dividend payments can be used to repay the director’s loan account, leaving a zero balance;
• this is a method frequently used by director & shareholders to repay their loan accounts and take remuneration.

If however a director’s loan account remains unpaid by way of dividends or PAYE/NIC at the end of the year, it is considered that the director/shareholder will have benefited from remuneration without paying tax on the same. To counteract this, HM Revenue & Customs imposes a charge on all company director’s loans that remain due at the year-end. Whilst this is not classified as a tax, (as it can be reclaimed if the directors’ loan is repaid), it acts as a tax on those who chose to draw their income as director’s loans without repaying them. For more information see our pages on loan charges and transfer of liability.

What happens if the company enters insolvency before a dividend is declared?

If the company is insolvent or in a state of company rescue then it is not possible to declare a dividend to repay a director’s loan account as there will be insufficient profit to allow this to happen.

• In this instance, then any liquidator or administrator is likely to request that the director repay the amounts that were paid to them by way of a director’s loan.
• There is a risk therefore that if a company is in financial difficulties and does not pay a salary to a director through the usual PAYE scheme, but allows the director to take money throughout the year with the intention of declaring a dividend to wipe out the loan at the end of the year, then a director may lose that money and have to repay it back to the company for the benefit of the creditors.

Issues for directors to be aware of

HMRC has enforcement measures in place to ensure that tax is not lost in the event of insolvency or other circumstances where directors loan accounts are outstanding at the end of the year, and therefore are never subject to a tax charge of any kind. As set out above, such loans, if still due at the year-end, will be subject to a charge (disguised remuneration).

• As a business owner it is important to be fully aware of all the remuneration methods available in order to maximise tax allowances, and the use of a director’s loan account can be key to this, as can the use of all PAYE / NIC allowances available to salary earners.
• It is important however that business owners to keep on top of the changing law in this area. HMRC are finding more ways to prevent what they consider to be tax avoidance, and directors loan accounts are sometimes used illegally in this way. The use of a director’s loan account also brings with it the risk of a director incurring personal liability in the event of insolvency. Our specialist tax dispute team is here to help on any tax related enquiry.

How we can help you

At Francis Wilks & Jones we have many years’ experience in acting for and advising directors and shareholders on the best way to approach remuneration in their company situation, and in advising on legal matters arising in respect of your tax liability, particularly with regard to claims out of insolvency or claims for breaches of a director’s fiduciary duties. Contact one of our expert team today for a free consultation to chat through your issues. Please call any member of our team for your consultation now. Alternatively email us with your enquiry and we will call you back at a time convenient for you.

Can my drawings be a directors loan?

Money drawn from a company by directors can be accounted for in several ways – as payments for expenses, as salary or remuneration payments, as dividends (where the directors are also shareholders) or – if none of the above apply – ultimately as directors loans.

The default position in a company where money has been withdrawn by directors is that such monies should be regarded as a debit to the directors loan account unless they can be accounted for otherwise.  

• a salary could be justified by an employment contract, payslips and tax returns. 
• remuneration can be justified by reference to a consultancy agreement or a service level agreement (dependant on the service period and whether shareholder approval has been obtained). 
• payments for expenses would be ordinarily justified by reference to the appropriate expense claim documents and receipts or invoices. 

A dividend payment would have to be supported by a Board Resolution to declare a dividend and this could only be legitimately passed if sufficient distributable reserves exist within the Company.

Otherwise, any payment to directors will likely be accounted for as a director’s loan and thus may lead to an overdrawn Director’s loan account, which may require Shareholder approval.

How we can help

If you would like to discuss anything related to directors loan accounts, please speak to our team today.

Directors and shareholders extraction of wealth

The drawing of wealth by both directors and shareholders is of key importance. After all, few would go into business in any capacity without an expectation of being paid for their troubles.

However, there are several points to consider when deciding how to provide remuneration, for both directors and shareholders. These focus on tax considerations, as well as protecting directors and shareholders and the company in the event of the cessation of trade, particularly if this is due to an insolvency event.

Directors’ salaries and service level agreements

In small or medium sized companies, directors and shareholders are often the same people. They are therefore likely to invoke a mix of methods of drawing money from the company, by way of salaries for directors, and dividends for shareholders, and a mix of both for owner/directors. There are other matters to consider too, such as expenses and benefits etc.

• Directors who are not shareholders will inevitably be employees of the company and will need to take their remuneration as salary.
• In this case it is advisable for a service level agreement to be drafted between the director and the company, so that all parties are clear on the parameters of the director’s role within the company.
• The service level agreement can be as detailed as necessary but should at the very least cover expectations in terms of salary and benefits.

Directors who are also business owners would also benefit from an SLA (or service level agreement) for the same reasons, so that pay and benefits are clearly defined, as well as the role they are expected to perform.

Directors loan accounts

However, directors will often take money from the company during the course of the year by way of a director’s loan account, which they later reconcile through the accounts and the tax system at the end of the year.

Dividends

A dividend is a payment made by a company to shareholders as a return on their investment. It can only be declared to shareholders if that company has made a profit after payment of corporation tax.

• Because of the frequent cross over between directors and shareholders, often directors are remunerated via declared dividends at the end of the year, rather than being paid a salary.
• The payment of dividends by way of remuneration needs to be carefully managed by the company and the director so that they do not fall foul of tax avoidance legislation, and so that directors are adequately covered should the company enter insolvency before a dividend is paid.

For shareholders, their drawings will depend on the amount invested, the amount of shares that they hold, and the class of those shares. There are various different ways in which shares can be held in the company, usually dependent on the type of company and the type of shareholding associated with the company.

Expenses

In most companies, there will be a need for directors and employees (and sometimes shareholders) to be paid for expenses that are incurred in running the company.

• This is normal, and expenses can often be applied against corporation tax to reduce taxation at the end of the year.
• However, it is important that expenses are dealt with directly within the company’s books and records, not only in order to meet tax obligations, but good records are essential if a company enters insolvency in order to protect those payments being attacked later with claims by a liquidator or administrator.

Connected companies

When a director is a director of one or more companies, then they will need to be mindful of their duties over all companies of which they are directors, and be particularly careful to ensure that conflicts don’t arise, or if they do, that they are correctly dealt with.

How we can help

At Francis Wilks & Jones we have many years of experience advising directors and business owners on the best way to draw wealth from their business interests, while protecting their personal interests, to avoid future personal financial liability or any accusations of misconduct. Contact us for a chat to see where we can help you. The most common areas for you to be concerned with are likely to be the following:

• directors’ salaries and service level agreements;
• dividends;
• income paid via directors loan accounts;
• tax-free loans and disguised remuneration;
• share classifications;
• accounting for expenses and insolvency;
• connected companies and directors duties.

At Francis Wilks & Jones you will always speak to someone at a senior level who will respond to any query you have immediately. Please call any member of our team today for an expert consultation. Alternatively email us with your enquiry and we will call you back at a time convenient to you.

Directors salaries and service level agreements

Directors salaries are clearly of significant importance in any company’s finances. A director is entitled to take a salary, or to take a dividend if they are also a shareholder and a company is in profit.

However, a limited company or limited liability partnership is a separate legal entity to the business owners or directors, and no matter the size or type of company, it is not appropriate for a director to simply take money out of the company without accounting properly for it, both in the company’s records, and in returns to HM Revenue & Customs (HMRC).

Directors’ remuneration

Directors may take a salary via the Pay As You Earn (PAYE for employers) scheme in the same way as any other employee. To do so, the director and the company must be registered with HMRC.

• National insurance contributions (NIC) may also need to be deducted depending on the salary level.
• many directors, particularly those running small family owned companies, will take a salary up to the NIC threshold, or up to the annual tax-free personal allowance threshold for PAYE, and take the remainder as declared dividends in order to benefit from the tax allowances available.

If you are a director and business owner, you might benefit from speaking to an accountant to decide on the most tax-efficient way of being paid as a director, if you have not already done so. At Francis Wilks & Jones we work with a variety of external experts and can put you in touch with a recommended accountant if required.

Directors’ salaries and service level agreements (SLA)

An SLA is a contract between a director of a private company, and that company, setting out the parameters of the directors role, similar to an employment contract with an employee.

• It is a good idea for all directors to have an SLA with their company to avoid misunderstandings and to ensure that all parties know what their expectations are in terms of salary and benefits and also what they expect from the director in terms of conduct.
• An SLA should set out full details of reimbursement of salary and benefits, such as medical insurance and life and disability insurance as well as details of where the director will work, holiday entitlement, sickness entitlement, and potential constraints on the director when leaving the company, amongst other relevant agreements.

At Francis Wilks & Jones we frequently advise companies on SLAs, and can chat through your requirements with you. Contact our team today to discuss.

Taking dividends from available profits

Directors are often shareholders as well as directors, particularly in small to medium sized companies. A shareholder is entitled to take a dividend from profits of the company, which will be calculated according to the percentage ownership represented by the shares they hold. Dividends can only be declared and paid on profits after corporation tax is paid. Individual shareholders will pay a dividend tax on any amounts received above £2,000.

• it is necessary to hold a board meeting for a dividend to be declared.
• a record must be kept of this in the company’s books and records by way of minutes.
• this is the case even with a sole director and shareholder company.
• a record will be required if this is ever requested by a later liquidator to look at the decision-making process in a company rescue  insolvency situation, or by HMRC to confirm tax due.

Directors’ loan accounts

It is common, especially for small or medium enterprises, for directors to take money from the company during the course of the year. If this is not taken as salary via PAYE, or declared dividends, it must be recorded in the director’s loan account on the balance sheet for the annual accounts for the limited company. Whilst this is fairly standard for owner/directors, there are potential problems for directors and the company if this is not dealt with properly as tax on directors loans must be accounted for properly.

At Francis Wilks & Jones our company law experts can advise and assist you with regard to what is reasonable and possible for directors in terms of taking money out of the business, and how to account for these properly within the company’s books and records, and tax returns.

• we frequently act for companies and directors in providing suitable SLAs, and can provide you with expert advice to enable you to reach agreement on the most common issues addressed in SLAs, and to cover bespoke points for your company situation.
• companies that have an SLA in place with their directors from the start can avoid a lot of time and costs in due course when misunderstandings occur over each party’s expectations.

Please call any member of our team for your expert consultation today. Alternatively email us with your enquiry and we will call you back at a time convenient for you.

Taxes due on directors loans

Director’s loans are one of the most common methods by which director’s draw funds from their company, either because they intend to declare a dividend at the year-end or to avoid the financial obligations they may be imposing on their company’s business.

It is only during the year, or when the year closes, that difficulties arise in accounting for such loans in order to avoid the taxes arising and the obligation to repay such sums.

Directors loans as loans

Where a director draws money from a company without accounting for it as income in the company’s books and records, it may be accounted for as a director’s loan.

• if a director’s loan, whether accounted for as a director’s loan or not, is unpaid at the year-end then there is a charge to tax comprising 25% of the amount outstanding as at the year-end.
• this charge is repayable to the company if the director repays the loan in its entirety.

However, if the loan is not repaid and instead written off, the tax will usually not be refundable. We recommend in such circumstances you seek advice from your accountant. If you need to be put in touch with an accountant, we have built up an excellent network of trusted advisers since 2002.

More seriously though, if a director’s loan is not repaid it will still remain a liability of the director and this can be a serious problem when the loan remains outstanding and the company is placed into insolvency.

Directors loans set off against dividends

Frequently a director may receive advice to take loans from the company and, at the year-end, declare a dividend which results in a paper transaction whereby the dividend declared is credited against the director’s loan account (provided the director is also a shareholder).

This, potentially combined with an income sufficient to absorb the director’s tax allowance, is a very common method of mitigating the director’s tax liabilities.

• however, this relies on the company being profitable and having sufficient reserves to enable such dividends to be declared when at the year-end, which is not guaranteed;
• if a director finds out at the year-end that s/he cannot take dividends to set-off their loan, they may be liable to repay the loan or, as a minimum, account for the 25% tax liability owed to HMRC as set out above.

Even worse, if a company is placed into insolvency at some point during the year (and before a dividend is declared) then the director’s loans will remain outstanding and be immediately repayable to the company in insolvency, potentially with added interest, even though such sums would not have been payable if taken as salary.

There are various claims that can be made against directors.

How we can help you

At Francis Wilks & Jones we are able to assist with any legal matters arising in respect of director loan accounts and any type of tax disputes or claims for repayment by insolvency practitioners or HMRC. We can also advise on breach of misconduct and a director’s fiduciary duties. Alternatively we can assist you in finding a tax accountant suitable to your needs, both in terms of their size and geography.

Tax consequences of writing off a directors loan account

So, an overdrawn directors’ loan account exists within your company and is therefore a debt due to the company. As with many debts due to companies, there are many reasons why the debt may be written-off.

For example,

• where a debtor has gone bust then the unpaid debt is almost certain not to be repaid and therefore needs to be written-off.
• this can have a number of implications for the company, including reclaiming any VAT paid upon invoices raised for such liabilities and setting off or correcting or adjusting the corporation tax paid in the year in which such invoice was raised, where such invoice was part of the turnover for the company.

HMRC’s position on writing off a directors loan account

HM Revenue & Customs makes provision for the writing-off of such liabilities. However, where it is a directors’ loan account being written-off then there are serious considerations to raise in terms of the likely suspicious circumstances of a write-off a sum due from a director.

• when a directors’ loan account is written-off then the director has received tax-free income:
• even if the writing-off is to provide for any contra-liability owed to that director, writing-off is not appropriate as this would not record the tax that would have been due on the contra-income that would otherwise have been paid to that director.

If a director has gone personally bankrupt or placed into an individual voluntary arrangement, and perhaps is no longer a director of the company (such individuals cannot be directors of a company until discharged from bankruptcy or their IVA is completed) then there may be a perfectly valid reason for writing off a director’s loan account.  

But this will not entitle a company to reclaim the section 455 tax already paid – which we deal with elsewhere in this guide and address these disclosure and payment requirements.

Example

For example, if the director had been loaned £100,000 in 2023, the Section 455 tax would have been £33,750. The company has lost £133,750 if the director’s loan is written-off.

Dangers of tax evasion

Quite commonly the real reason for the write off is to evade liability for tax and HMRC relies upon the disclosure of such a write-off within the company’s corporation tax return so as to ensure it has an ability to investigate the reasons for the write off.

• Of course, this does rely upon the previous disclosure of the directors’ loan account balance to HMRC.  If the director’s loan was never disclosed, then the consequence of writing off and not accounting, for what effectively is disguised remuneration, can include criminal consequences.
• Further, such deliberate evasion means that the limitation period for HMRC’s claims could be as long as 20 years.

Company insolvency & liquidation

Further, if a company is placed into an insolvency procedure and has recently written-off directors’ loan accounts then it is highly likely that an appointed administrator or liquidator may pursue the director on the basis that such a write-off of the director’s loan account was a breach of his/her fiduciary duty to the company.

Taxation of overdrawn directors loan account

A directors’ loan account is a loan to a director and does not ordinary incur tax liabilities. As with any other loan, it is normally repayable upon demand and conventionally there are no provisions for HMRC to tax loans to individuals as if they were income.

As set out elsewhere in this guide, a director’s loan comes with a responsibility to repay it – which may be achieved by the company’s performance during the financial year, and therefore dividends paid at the end of that financial year.

Interest or no interest on the loan?

If a director’s loan is advanced free of interest, then the director gains the benefit of an interest-free loan, whereas a similar loan would attract commercial rates of interest in the open market. This interest saving is a benefit in kind to the director and therefore may be taxed as such in the director’s personal tax returns.

However, there is a risk of tax avoidance when permitting an unregulated directors loan to be transferred from a company which is also controlled by the borrower.

Section 455 tax payable at the end of the financial year

Accordingly, when there is an overdrawn director’s loan account as at the year-end, there is a requirement for the company to account for a tax charge on the unrepaid sum, to provide against the risk that the unpaid amounts is never repaid.  This tax is levied pursuant to section 455 of the Corporation Tax Act 2010 (replacing former provisions under Section 419 of the Income and Corporation Taxes Act 1988).

• The Section 455 tax arises when a director’s loan account has not been repaid and remains overdrawn as at the company’s financial year-end.
• A company’s financial accounts of course do not have to be immediately filed with Companies House (in respect of the abbreviated accounts) and with HMRC (in respect of Corporation Tax) until some period between 9-10 months after the financial year end.
• Within this period of time the directors together with their accountants can reconcile and adjust accounts in accordance with accounting standards to adjust any directors loan balances as at the year-end, and present this information both to HMRC and the Registrar of Companies when such tax returns and accounts are filed.
• The Section 455 taxation will arise on any advances during the year. It will not arise upon the running total of an overdrawn directors’ loan account, which may have been taxed already in previous tax years. It is therefore a one-off payment on an overdrawn directors’ loan account and further payments will only be sought where further loans are sought from the company.

Repayment of loan and s.455 tax reclaims

Where a director repays his loan from the company then HMRC will of course repay the Section 455 tax on the proportion of the loan taxed and then repaid. Such a reclaim can form an asset of the company in the event of a liquidation, where a director’s loan is claimed back from the director by the company’s liquidators and then HMRC is contacted to seek repayment of the Section 455 tax.

Additional payments & penalties for non payment of 455 tax

If the Section 455 tax is not paid within the requirements of the tax rules then there may well be additional penalties and interest accruing on such tax liabilities.

A director who runs a company with continuously overdrawn directors’ loan accounts yet does not account to HMRC for the tax on such overdrawn directors’ loan accounts faces a double jeopardy of a future risk of both the tax liability and the liability to repay the director’s loan.

Short term benefit or long-term headache?

What can appear to be a short-term benefit can lead to a long-term liability hanging over the directors’ heads personally.  From the company’s perspective, even where the directors loan is eventually declared and then paid, there could still be the late payment penalties and interest that will still need to be paid (even though the principle sum loaned has been deemed repaid).

Your accountant should always discuss with you the taxation of an overdrawn directors’ loan account and reconciliation of the overdrawn directors’ loan accounts as at the financial year end.

What triggers a section 455 tax charge?

As stated elsewhere in this guide, overdrawn directors’ loan accounts at the financial year-end will be subject to a tax charge pursuant to Section 455 Corporation Tax Act 2010.

If a company has made further advances to a director which have not been off set by dividends, remuneration or expenses then the overdrawn directors’ loan account will likely have increased during the accounting period and therefore that increase will be subject to the Section 455 charge.

Increase in aggregate value triggers section 445

The trigger for the Section 455 charge is an increase in the aggregate value if an overdrawn director’s loan.  It is not triggered by a directors loan account in credit or a directors loan account which stays the same from the previous year (provided the section 455 charge was previously paid) or which is less overdrawn (as this signifies a partial repayment).

Effect of director loan repayment

There is no section 455 tax charge where the loan was outstanding as at he financial year-end but was repaid by the director during the 9 month period that follows the year-end (i.e. the period during which the return for the section 455 charge should be made).

Different account periods

As stated in elsewhere in this guide, a Section 455 charge will not be charged against the same sum each year and so if, for example, you have a director’s loan which sits at the same balance for several years then the balance will not be subject to a Section 455 charge other than in the first year in which the charge arose (and was paid).

Voluntary disclosure requirements

The Section 455 charge is a voluntary disclosure and will normally be calculated by the company’s accountants. The disclosure will be to HMRC as part of the Corporation Tax Return and will require payment of the charge upon filing that return.

If there is no return disclosing this liability to HMRC, then the section 455 charge will be increased by penalties and interest.

What is the current rate of s455 tax?

The section 455 charge was historically 25% but in recent years has increased to the current rate of 33.75%.

Penalties and repayment

If a director in a subsequent period repays the director’s loans, whilst this may lead to an annulment of the Section 455 charge there will still be the late penalties and interest outstanding which will remain due from the company or LLP.

There is no benefit to the director in not voluntarily disclosing an overdrawn directors’ loan and further there is a requirement to make such disclosure in the company’s financial accounts in accordance with accounting standards and the Companies Act 2006 (as amended) as set out on our separate webpage which addresses the requirement to disclose directors’ loans.

Directors loans exempt from s.455 tax charge

The Section 455 charge is only applicable to directors’ loans where the loan is from a company which is described as a “close company”.

Close companies explained

A close company is a company that is owner managed by the same individuals and usually by five or fewer shareholders (who are described as participators).

• This description covers a large amount of the SME companies in the UK, most of which are owned and managed by the same shareholder directors (who usually number five or less and therefore fall within the definition of a close company).
• If your company is not a close company, then you may be outside of the Section 455 tax. However, if it is a close company then you will be defined as a participator and will be subject to the Section 455 tax due on any loans to you by the company.
• Detailed guidance on Close companies can be found in the HMRC internal company taxation manual CTM61505.

There are however additional exemptions

1. Money Lenders

The Section 455 tax is not applicable to loans made in the ordinary course of business carried on by a company, provided that the business is one where you are lending money.

• There are legal definitions of what a money lender is, as a business, and the characteristics associated with such business will define whether your business falls within this definition.
• You should seek professional advice as to whether your business falls within the definition of lending money for the purpose of the Section 455 tax.

2. Employed Directors

Otherwise, loans to directors may not fall within the Section 455 tax where conditions A, B and C are met in accordance with Section 456 of the Companies Act 2006.

• This covers directors’ loans of small amounts, below £15,000 and where the directors are full-time and do not have a material interest in the company.
• For example, an employed salaried director of a company who took a loan of £8,000 would not incur a Section 455 tax liability to the company, even if it remained unpaid more than 9 months after the company’s financial year-end.

3. Share Capital

Additionally unpaid share capital which is being called up is not considered to be a loan by the company, although the advent of E-share tax avoidance schemes in recent years has exploited this exemption and created a dilemma in this area.

• Generally, E-shares are considered to be disguised remuneration and therefore are subject to income tax charges where the E-shares have not been called-up for payment.
• For more information on E-shares and directors’ loans please see separate webpages on directors’ loan accounts and E-shares or just call our team today.

PAYE implications of non-repaid director loans

Directors’ loans are generally loans by the company and therefore are not subject to income tax charges against the director (but via the company via the payroll).

The issue of tax only arises on income falling within the definition of The Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). As a loan by its very definition is repayable to the lender, then this does not fall within the definition of income under ITEPA.

When can a directors loan account be defined as income?

There are various circumstances in which an overdrawn directors’ loan account may be defined as income. For example

• where there was never any intention to repay the loan and the fabrication of the advance to directors is purely for the purpose of disguising remuneration, then such disguised remuneration may be subject to tax.
• The section 455 tax charge against the company will be due (provided the loan has been disclosed) upon the filing of the company’s corporation tax return.  Such tax will remain paid to HMRC (or payable together with interest and charges if not repaid) until repayment of the director’s loan.
• If the director never repays such loans, then the company will never recover the tax paid on such sums. As the company is liable to remit PAYE and NIC to HMRC on any income paid to a director (within the definition of ITEPA), then this mitigates the risk of non-collection of PAYE/NIC to the treasury (i.e. HMRC).

Conversely, the director’s loan may be worse for the director than the apparent initial benefit. Because, as well as the Section 455 charge imposed on the company, the director will have received tax-free remuneration which he may be required to account for in his personal tax return.

The General Anti-Avoidance Rules

The General Anti-Avoidance Rules 2013 and associated tax avoidance legislation provides that a director must account for any income received which has not been subject to tax.

• Directors should seek advice from their accountants in this respect as the failure to account for such tax and remit any such tax sums due could lead to serious problems in terms of late payment interest and charges and further the failure to disclose such receipts may extend the limitation period for any claims to be brought against such directors.
• There are also potential tax evasion criminal proceedings that a director may face and at Francis Wilks & Jones we assist many directors in dealing with late disclosure meetings protecting them from criminal prosecution.

In addition to the loan itself, a director receives a director’s loan often without any interest. This interest saving may be a benefit in kind and we refer elsewhere in this guide how to deal with such risks.

Converting directors loan in to remuneration

It is not unusual for directors of companies to seek to convert their directors’ loan into remuneration, often late in the day. This remuneration may well be converted to a salary, with the result that there is an immediate charge to PAYE/NIC. The director may consider that the tax charge is less onerous than repaying the director’s loan and further it may be possible to seek recovery of any Section 455 tax remitted to HMRC as a credit against the PAYE tax charge.

• This behaviour is not recommended. The late submission of such tax returns and charges to PAYE/NIC will lead to large penalties and interest charges by HMRC which may serve to outweigh the benefit of taking this approach.

Director loans and company insolvency issues

Further, at Francis Wilks & Jones we have seen numerous occasions where directors have taken such action just prior to liquidation with a view that the company in liquidation will be liable for the tax rather than the director being liable to repay the overdrawn loan.

• This can lead to numerous problems, one of which may be that a liquidator may pursue the director nevertheless for the loan on the basis that the conversion of the loan to remuneration was a breach of his fiduciary duties to the company.
• Under Section 172(3) of the Companies Act 2006, a director’s duty to the company extends to its creditors where the company is insolvent or likely to become insolvent because of any such steps taken.
• Further to this a director also faces the additional risk that, as regards the National Insurance component, HMRC may seek to pursue the director for a personal liability notice amounting to the National Insurance sum which would have otherwise been payable on such remuneration had it been accounted for at the appropriate time to HMRC. We regularly deal with personal liability notices which address these concerns and how we can assist directors in negotiations with HMRC should they seek to impose such a liability on a director.
• There are additional risks of security being sought from that directors subsequent businesses. 

In summary, the attempted “clever” use of a directors loan account can seriously backfire and lead to a far more drastic situation. If you need any help or advice at all on director loan accounts – call our team today.

Tax avoidance and directors loans

Directors’ loans are perhaps the oldest form of tax avoidance mechanism that has been in regular use within companies ever since the Companies Act 1985 (and its predecessors) were brought in by parliament.

As far back as 1988, there was a section 419 charge which applied to unrepaid directors loans.  The existence of the current section 455 charge reflects the serious risk which directors loan accounts bring.

How does a DLA work?

A director’s loan enables a director to draw sums of money from a company without accounting for tax and with the benefit of his/her personal control over when it is repaid and when demands are made for repayment.

• The public interest, which is served by taxation on profits and all income, is therefore dependant on such loans being repaid to a company to ensure there is no risk of an unlawful distribution of a company’s profits or assets.
• Directors’ loans are commonplace in small companies (referred to as close companies) where the close degree of control by the borrowers over the terms of repayment of the sums they have borrowed removes any risk (to directors) of a demand being made for repayment against the director’s wishes (as would happen with an ordinary personal loan).
• A director’s loan would not work in this way in a larger company where the interests of that single director (or directors) is not prioritised over the company’s need to maintain tight fiscal control over its cashflow and financial position.

However, most directors loans are not tax avoidance schemes and so the legislation permits their use. To maintain the integrity of the economic marketplace.

Tax avoidance schemes

A tax avoidance scheme commonly acts to pay remuneration without liability of tax to a director, contractor or participating employee as an expense to the company and therefore can be claimed as a tax deductible expense from the corporation tax liability.

• Legislation over the past 20 years has sought to remove the double benefit of tax avoidance schemes i.e. where the expense is deducted and the director’s personal tax liability is avoided,
• legislation prohibits such approaches and prosecutes any schemes intended to avoid liability for income tax (income which should rightfully be remitted to HMRC under the Income Tax (Earnings and Pensions) Act 2003).

As with the section 455 charge, disclosure and transparency is essential and, as with the section 455 charge, there is always a review and a “payment just in case”, often by way of an Accelerated Payment Notice or APN.

Tax avoidance scheme are many varied and we refer to our pages on employee benefit trusts and employer finance retirement benefit schemes which address some of the most common schemes used and now outlawed by the Finance Act (No 2) 2017 and associated legislation.

Tax free loans and disguised remuneration

Our tax dispute team is headed by Andy Lynch – who has 18 years’ experience working for HMRC before joining FWJ. Backed by a team of expert lawyers, we provide defence advice and assistance on a wide range of tax disputes.

The most usual form of taxes which arise in a small and medium sized company are PAYE and National Insurance due on employees’ salaries (including directors), VAT if applicable on goods and services which are collected by the supplier on behalf of HMRC, and corporation tax chargeable on a company’s profits.

• Most responsible directors and shareholders in small or medium companies will have taken advice from a reputable accountant on how to pay staff and directors and shareholders in the most tax efficient way possible
• but they also ensure that they do not fall foul of either tax legislation or legislation concerning duties to the company.

Disguised remuneration

In recent years, some directors and shareholders have gone further than to look at the most efficient use of the tax thresholds, and have used ‘disguised remuneration’ schemes in order to try to avoid liability for tax on their income. The increased use of such schemes over recent years has led the government to introduce more and more legislation to prohibit schemes set up solely for the purposes of avoiding tax. Our website deals extensively with disguised remuneration and abuse of a director’s loan accounts in our tax disputes section.

Employee benefit trusts (EBT)

One of these disguised remuneration schemes is an employee benefit trust. This usually involves an employer paying a person through a loan from a third party, the employee benefit trust.

• these are used by employers or umbrella companies as an alternative to paying a salary which would normally attract tax and national insurance liabilities.
• it is effectively a loan to an employee on terms that are unlikely to be repaid. HMRC has now closed this loophole, and these loans have to be settled with HMRC.

Director’s loan accounts tax avoidance

It is common for director shareholders to take money from the company for living expenses over the course of the year with the expectation of accounting for them in the accounts at the end of the year and meeting the tax requirements at that time.

• monies taken in this way must be recorded in a director loan account to be reconciled at the end of the year, and tax paid on the income, whether that is by way of PAYE/NIC on salary or tax on dividends declared to repay the director loan account, or a mix of both.
• however, if these loans are not repaid at the end of the year, and subjected to appropriate tax charges as remuneration, either by way of dividends, or PAYE, or both, they can also be viewed as director’s loan accounts tax avoidance, or disguised remuneration.

Charges on outstanding DLAs

Loans to directors given instead of salary but never repaid are subject to laws brought in by HMRC to combat tax evasion. If a director loan account is not settled by way of properly declared dividends or put through the PAYE scheme at the end of a year, then HMRC imposes a charge on all DLAs that remain due at the year-end.

• whilst this is not a tax (as it could be reclaimed if the loan was paid back), it acts as a tax on those who take income as director’s loans without repaying them through a legitimate tax channel later. Find out more on our legal changes and loan charges page.
• the ‘HMRC Loan Charge’ is a method by which HMRC enforces the obligation to pay tax via a charge against sums loaned (which, as a loan, would otherwise not be liable for tax).

Risk of personal liability with a DLA

In addition to the risk that directors and companies leave themselves open to in terms of tax liabilities to HMRC, if a company enters insolvency, then any directors with an outstanding DLA to the company will inevitably also be asked to repay these loans for the benefit of the creditors of the company in claims by a liquidator or administrator.

How we can help

At Francis Wilks & Jones we frequently advise companies on all aspects of tax and legal matters that arise within a company situation. Our tax dispute team has many years of experience of dealing with tax disputes of all kinds, and our company rescue team specialises in claims arising out of insolvency and breach of directors’ duties. If any of these matters affect you or your business, the sooner you speak to an expert, the greater the chance of resolving the issues. Contact one of our friendly team today.

The benefits of a directors loan account

1. Flexibility.

A directors’ loan account is incredibly flexible. It provides a mechanism to deal with all the directors personal needs and expense reclaims as and when required on a day-to-day basis without the requirements to keep the company’s payroll system updated.

Of course, as we set out elsewhere, it is vital that accurate accounting records are maintained to demonstrate that there has been no abuse of the director’s loan account.

2. Access to funds.

Directors can use the director’s loan account to access funds from the company, providing a convenient way to meet personal financial needs or investments without relying solely on salary or dividends.

3. Flexibility in cash flow management.

A director’s loan account provides flexibility in managing cash flow. Directors can borrow money when they need it and repay it when they have surplus funds, helping to smooth out personal and business financial fluctuations.

4. Avoidance of formal debt arrangements.

Unlike external loans, a director’s loan account is an informal arrangement within the company. This can be advantageous for directors who prefer a less formalised borrowing process without the need for external credit checks or loan agreements.

5. Interest-free loans. 

In some cases, directors may be able to obtain interest-free loans from the company. This can be a cost-effective way to access funds compared to external borrowing, where interest charges may apply.

6. Tax planning.

Directors may use the director’s loan account for tax planning purposes. For example, they can strategically time repayments to manage personal tax liabilities or utilise the account for specific financial planning strategies.

The benefit of a directors’ loan account is also that there is no tax consequence whilst it runs and during the financial year, although this will change as at the year end where HMRC will look at the directors’ loan account to examine whether it is actually a method of unauthorised remuneration and make Section 455 tax charges accordingly.

7. Bridging finance.  

Directors can use the director’s loan account as a short-term financing option to bridge gaps in personal finances, especially during periods when personal and business cash flows may not align.

8. Investment opportunities

Directors may use funds from the director’s loan account for personal investments or business-related opportunities without the need for external financing. This can be particularly beneficial when quick decisions or immediate funding is required.

9. More freedom to concentrate on your business

A director should ideally focus on running their business and being relieved of additional tax and remuneration concerns is a blessing.  This is particularly so where the director invests funds to start up or continue a business, and can then withdraw such funds in an efficient manner once the business starts to make profits.

10. Ability to run the directors loan account in different ways

There are various ways to operate a directors loan account and this largely depends on the type of business, the anticipated timing and speed of cash flow and the owner-managers’ strategy for the business.

• If a director draws sums during the year, he/she may choose to draw directors loans at a lower amount and then, subject to the profit made, determine the final sums payable to them for the year at the year end.   This balances the directors personal wellbeing and needs with the business’ success.
• In the alternative if the director draws too much during the year, then at the year end it enables him/her to reconcile their drawings to what the company could afford and repay such sums.  We refer to our separate webpage which addresses the risks of a directors loan account.

But provided a directors loan account is used properly, its flexibility, reduced cost and ease of use provided a great benefit to directors running a company in an increasingly highly regulated world.

11. Dividend timing.

Directors can use the director’s loan account to manage the timing of dividends. For instance, if the company has a profitable year, a director may delay taking dividends until a more tax-efficient time.

Summary

While a director’s loan account can offer flexibility and benefits, it’s important for directors to use it responsibly and in compliance with legal and tax regulations. Overdrawing the account without proper repayment or failing to adhere to reporting requirements can lead to legal and financial consequences. Seeking advice from financial professionals, such as accountants, can help directors make informed decisions regarding the use of the director’s loan account. 

At FWJ our team regularly advises directors on all aspects of director loan accounts.

Risks associated with DLA withdrawals

There are risks associated with running a directors’ loan account and making withdrawals from a company this way.

1. Insolvency.  

If the company falls into an insolvency process during the year, then claims by a liquidator or administrator for repayment of the director’s loan are likely once it is in a formal insolvency process.

• The above risks can have impact on any transactions entered into some years before the insolvency process occurred, provided insolvency or the likelihood of insolvency can be demonstrated.
• If a company becomes insolvent, creditors may scrutinise directors loan accounts to assess whether funds were improperly extracted from the company, potentially leading to legal action.

2. HMRC scrutiny.  

If a company has negative reserves or does not make a profit during the year then there is no ability to draw a dividend from the company and so the director has a liability which cannot be undone and which will cause the company further financial problems as it will have to account for a tax on the balance, to HM Revenue & Customs.

3. Invalid rights to repayment.

A director may seek to claim sums due to him / her (to repay the directors loan account) as earnings.  But at law a director does not have a legal right to a salary and this has been further supported in recent years by judgements setting out that contractual rights to a directors salary only exist where the intention to draw such a salary can be evidenced.

4. Financial strain in the company.

If directors consistently borrow significant amounts from the company without repaying them, it can put a financial strain on the company’s resources. This may affect the company’s ability to meet its financial obligations and invest in growth opportunities. It might even push it towards needing some form of company rescue.

5. Overdrawn Director’s Loan Account.

One significant risk is when a director’s loan account becomes overdrawn, meaning the director has taken more money from the company than they are entitled to.

If the overdrawn balance is not repaid within nine months of the company’s financial year-end, the company may be liable to pay additional Corporation Tax.

6. Tax implications.

Depending on the transactions in the director’s loan account, there can be tax implications for both the company and the director.

• If the company charges the director below-market-rate interest on the loan, it may be treated as a benefit in kind, subject to tax.
• Failure to report and settle tax liabilities can result in penalties and interest.

7. Non-Compliance with company law

Violating the rules and regulations governing director’s loans under the Companies Act 2006 can lead to legal consequences.

Companies and directors must comply with reporting requirements and ensure that any loans are properly authorised and documented.

8. Impact on dividends

If a director’s loan account is overdrawn, it can affect the ability to pay dividends to shareholders.

• Overdrawn director’s loan accounts can restrict the payment of dividends until the account is brought back into credit.
• As with all businesses, the personal interests of the directors are closely aligned to the success of the company.

Unlawful drawings from a company

Where a payment or distribution is made by a company to its directors/shareholders in breach of contracts with the company or the legally permissible routes available under the Companies Act legislation (and associated regulations or accounting standards) then the transfer of such monies or in specie assets will generally be regarded as an unlawful distribution.

• An unlawful distribution could be a dividend paid to shareholders or credited against their directors loan accounts (where such shareholders are also directors) where there are no distributable profits.
• Alternatively, an unlawful distribution could be a payment of salary to an individual who is not an employee of the company. Where no statutory or general contract exists between the recipient and the company, then the receipt of such sums is generally an unlawful distribution, potentially attributable as a directors loan where the recipient is a related party.

Immediate repayment required of unauthorised distribution

When an unlawful distribution arises then such sums are immediately repayable to the company. An unlawful distribution could include sums paid to directors, contractors or employees via a tax avoidance scheme, although this will depend on whether the company is solvent or not.

• Where illegal dividends are paid to shareholders then there is a risk that a shareholder of a company may be subject to both a claim for an unlawful distribution and a claim for repayment of the dividend.
• Similarly, where a directors’ loan account is written off then this could also comprise an unlawful distribution as it would be a monetary relief provided for the benefit of a director without any entitlement to such remuneration and is further increased by any failure to account for the section 455 tax charge.

Generally such unlawful drawings, and the defence of any claims for restitution of such sums, is dependant on the company’s solvency, the contractual rights of the directors/recipients and any advice received or good faith aspects.

In the event you have any concerns as regards distributions to be made by or on behalf of the company then it is essential you seek legal advice as soon as possible on such distributions as the consequences can often outweigh the benefit of the steps proposed.

Is an overdrawn directors loan account illegal?

A directors’ loan account can be both in debit and overdrawn (in credit – you owe the company money).

What is an overdrawn directors loan account?

An overdrawn directors’ loan account is where the company has loaned money to a director and such sums have not been repaid.

• A directors’ loan account is often overdrawn during the year until the financial year end where such balances are adjusted to account for dividends declared or profits arising during the financial year.
• So, in this scenario, for most of a business’ life the directors loan account will be overdrawn.  This is perfectly acceptable although we refer elsewhere in this guide the practice (which is more suspicious) where an overdrawn director’s loan account is written off.

Unlawful directors loan account.

A directors’ loan account would however be unlawful where the loan has been obtained in breach of the legal requirements for such a loan. If a director’s loan is made to a director who is also a shareholder, is above £10,000 and shareholder approval has not been sought, then technically it is not a directors loan but is an unlawful drawing (section 847 of the Companies Act 2006 (as amended)).

Where a director adheres to these legal requirements then an overdrawn directors’ loan account will not be illegal but directors should be aware of further risks of reliance on a directors’ loan account.

The effect of company insolvency

An overdrawn directors’ loan account is a debt owed to the company.

• If the company is placed into insolvency or has its assets frozen then the directors’ loan account may be repayable and where there is a downturn in business such that the business ceases to be profitable (as occurred recently when Covid-19 hit) if the directors loan account and dividends was how a director paid themselves, then the director may find himself or herself without any source of remuneration.
• This can of course be remedied with swift advice and our expert team is here to help.

How we can help

At Francis Wilks & Jones we often see claims for overdrawn directors’ loan accounts where the director did not realise that they would not be able to draw a dividend and where a company (possibly at short notice) is placed into administration or liquidation.

If a director does not have the business accounting records and service level agreements in place, then they face a great deal of personal financial risk.  Further, for credit balances where the director is owed a director’s loan balance, where a company was facing trading difficulties or is at risk of insolvency, it would be a breach of a director’s fiduciary duties to repay himself this loan.

Can an overdrawn directors loan account be offset?

An overdrawn directors’ loan account is a debt due to the company from the director.

• This can include transactions not recorded as a directors loan for example where the company has guaranteed a personal liability, where a similar transaction has been entered into for the benefit of a related party or where a non-monetary benefit has been provided to the director or a related party.
• Additionally, an overdrawn directors loan will be subject to a tax as at the year end pursuant to Section 455 of the Corporation Tax Act 2010.

Offsetting dividends against overdrawn directors loan account

Quite commonly, a director’s loan will nevertheless be overdrawn during the company’s  financial year and companies often operate in this way so as to mitigate the regulatory and financial tax burden of remuneration, and enable dividends to be offset against such overdrawn directors’ loan account balances at the year end.

• This is often a recommendation that your accountant will provide and, whilst it is a tax efficient and sensible method of running a business, a director always has to be aware of the risks involved.
• We refer you to other sections of this guide which deal with your accountant’s recommendations and the inherent risk of a directors loan account.

Reducing a directors loan account by offsetting expenses

A directors’ loan account can also be reduced by setting off expenses incurred by directors acting in the company’s business.   This again has risks where no clear records of such expenditure are retained as part of the company’s books and records and elsewhere in this guide we address the need for accurate accounting records.

• The directors’ loan account is similar to an inter-company account whereby credits and debits for costs and expenses of business and the remuneration of directors is recorded, such that an overdrawn balance should be the difference between the two.
• So yes, expenses and other costs incurred which are due to be repaid to a director can instead be used to off set against any balance due to the company as a result of an overdrawn directors’ loan account.

Be careful to avoid mistakes

But be careful, as most owner managers of businesses often blur the line between their interests.  For an LLP, this is more straightforward – the historic capital and current accounts for a partnership are amalgamated in an LLP.  But for a company, an owner manager has to distinguish between their interests as director and their interests as shareholder.

• Whilst dividends are normally employed to be set off against overdrawn directors loan accounts, this is only permissible where the company is solvent and trading.  Where, for example, dividends are declared but then the company faces insolvency, it is likely that the dividends cannot be paid and therefore the overdrawn directors loan account cannot be offset (and the balance is therefore repayable from the director’s personal assets).
• There are of course, as with all areas, grey areas which are not covered by the above description. Provisional or anticipated benefits for directors should not ideally be off set with a directors’ loan account unless they are payable. 
• Similarly, transactions entered into which are in breach of HMRC’s General Anti-Avoidance Rules 2013 or otherwise comprise a tax avoidance scheme should not ideally be set off against the directors’ loan account. Examples of such arrangements are E-shares where an obligation to pay uncalled issued “E-shares” is entered into in consideration of a set off of such sums against an overdrawn directors loan account balance.   We address this on a separate webpage dealing with e-shares and directors loan accounts.

As with all such matters, we recommend that you seek professional advice on your directors’ loan account and ensure that any transactions offset are legitimate transactions between the director and the company or LLP.

Our expert team is here to help today.

Is an overdrawn directors loan account a benefit in kind?

An overdrawn directors’ loan account is effectively a loan from a company which a director may or may not control and which is usually described as a “close company”.

What is a “close company”?

A close company is usually one that has identical (or similar) directors and shareholders numbering up to 5.  For such companies the owner-managers are described as “participators” and additional restrictions are imposed on the basis that fraud or deception of regulatory and legal matters is easier for a close company to carry out. Detailed guidance on Close companies can be found in the HMRC internal company taxation manual CTM61505.

• Directors’ loans are frequently a source of such deception, as they comprise tax free advances that are not always obvious in the company’s financial accounts or which may be difficult to trace (given that there are approximately 5 million companies registered at Companies House).
• A directors’ loan in of itself is a loan and is therefore repayable.  There is of course the risk that it is not repaid, in which case tax legislation (the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”)) may later adjudge such no repaid loan as income.
• However, subject to HMRC carrying out any such enquiry, as a loan it will not be a benefit in kind.

However, this does not mean that there is no penalty.  Any directors loan that remains outstanding as at the year end will be subject to a section 455 tax which is payable to HMRC in addition to other corporation tax and payroll tax liabilities.  This is only refunded by HMRC is the directors loan is properly repaid to the company.

A possible benefit in kind?

However, there is a second category that may be a benefit in kind.  A directors loan is often advanced without interest or at significantly reduced interest rates and therefore the director benefits from the interest otherwise saved when compared to what would be available as an ordinary personal loan.

• Whilst a few years ago this may have been a very marginal saving because of low interest rates prevailing, currently this is not such a marginal saving and accordingly significant interest would be payable for most loans obtained on the open market.
• The amount of this benefit may also be affected by the director’s personal circumstances and their credit worthiness.

Importance of accurate record keeping and filing

As with all benefits in kind, upon filing a personal tax return the company should file a document setting out the benefits provided to the director who will be required to account for them in his/her personal tax return.

The business should record any interest free loan as a benefit in kind within such returns, as regards any absence of an interest charge.  To avoid this it is recommended that directors loans are charged to a commercial rate of interest, which would then eliminate the risk that a benefit in kind has been paid (which is taxable at potentially higher tax rates).

Risks of overdrawn directors loan account

A director’s loan account whilst overdrawn creates a liability owed to the company from the directors.

Breach of fiduciary duty as directors

Ordinarily this creates a conflict which directors should be aware of when considering their fiduciary duties to the company. Acting in conflict with the company’s interests may be a breach of the director’s fiduciary duties and the company has a right to seek equitable compensation from any director who breaches such fiduciary duties which creates a loss. We have a specialist team who can advise on breach of directors fiduciary duties.

Cashflow problems

An overdrawn director’s loan account, where loans have been made to directors, also causes obvious cashflow problems. The company may not be able to continue operating if it is continuously lending funds to directors, particularly where such monies are not being repaid.

Additional amounts payable to HMRC

Additionally, if such loans are not repaid, then the company has additional obligations in terms of the Section 455 tax which it must remit to HMRC. This tax is 33.75% (as of writing) of the aggregate loan made and this may cause a considerable additional financial burden to the company.

Alternatively, if no such loan and/or Section 455 tax is accounted for to HMRC, or is accounted for late, there are further additional interest penalties and charges that may become due from the company.

• From the director’s point of view the risk of an overdrawn director’s loan account is quite simple.
• They will have to repay it at some point. Ordinarily companies repay the directors’ loan accounts by declaring dividends in favour of those same directors (who may also be shareholders for close companies) and thus there is an offsetting of their interest as shareholders from their debt due to the company as directors.

Risks on insolvency of the company

Where a company faces insolvency concerns, there are serious risks to the directors personally.

• If a director has a loan account which is overdrawn and the company is placed into liquidation before the financial year end (which almost always occurs) then the directors do not have the opportunity to declare dividends from the company.
• If they cannot declare dividends then they cannot set off the sums due on the director’s loan account and therefore, once the company is placed into administration or liquidation, the appointed administrator or liquidator will demand repayment of that loan.

Claims can arise many years later

Further, under the Limitation Act 1981 (as amended), directors’ loan accounts (as with all loan accounts where no repayment deadline is stated) are not repayable unless and until demanded.

• Directors will always forget to make such a demand of themselves as they do not want to create a liability; however, the downside to this strategy is that limitation extends and even if you have a director’s loan account from 20 years ago if it was not demanded to be repaid then an appointed liquidator or administrator could demand repayment now.
• It is likely that there are insufficient books and records available to prove such a liability but it remains the case that limitation does not protect a director from any claim for repayment of their director’s loan account.

Failure to maintain good records can lead to paying more back

Further risks arise where a director seeks to set off any liability for his directors’ loan accounts, for example claiming that he was due salaries or was due repayment of expenses paid on the company’s behalf. For expenses, a director needs to ensure that accurate records of such expenses are retained and for claims of set off in respect of remuneration, the director has to establish grounds or a legal basis for such a claim for remuneration. This is not always straightforward.

• Whilst a director’s loan account is a remarkably flexible tool it has to be used wisely and properly. Any attempt to use it to abuse your position as a director may lead to far more drastic consequences than the benefit originally provided.
• Even for the innocent directors using director’s loan accounts, they should be fully aware of the risk they face in taking loans where the loans are taken in expectation of future dividends or other income due from the company (which do not always arrive).

Additional corporation tax can be payable

One of the primary risks is that an overdrawn director’s loan account can lead to additional Corporation Tax for the company. If the loan is not repaid within nine months of the company’s financial year-end, HM Revenue & Customs (HMRC) may impose tax on the outstanding balance.

Tax on beneficial loan

If the director is not charged market-rate interest on the overdrawn amount, HMRC may treat the difference between the interest charged and the market rate as a benefit in kind, subject to income tax.

Impact on dividends

An overdrawn director’s loan account may restrict the company’s ability to declare and pay dividends to shareholders. Dividends cannot be paid if the company has distributable profits but an overdrawn loan account.

Breach of company law

An overdrawn director’s loan account may breach the rules set out in the Companies Act 2006. Failing to comply with these rules can lead to legal consequences, including fines and potential disqualification of directors.

Director’s personal liability

Directors can be personally liable for the overdrawn amount. If the company is unable to recover the funds and the director is deemed to have taken an unlawful dividend, they may be required to repay the amount personally.

Impact on credit rating

An overdrawn director’s loan account can impact the company’s credit rating. Lenders and creditors may view this as a sign of financial mismanagement, making it difficult for the company to secure credit in the future.

We can help you

To mitigate these risks, directors should ensure that any overdrawn amounts are repaid promptly or properly documented, and interest charges should comply with market rates. Seeking professional advice from our expert director loan account team can ensure that risks associated with overdrawn director loan accounts are dealt with promptly and professional. Call our team today.

Company solvency and overdrawn directors loan account

A director’s loan account is a balance due from or to a director of a limited company and, for LLPs, similar principles apply as regards the LLPs partners.

What is an overdrawn director loan account?

Where a director’s loan account is overdrawn, this means that the company has lent the director funds which have not yet been repaid.

• Tax liabilities may arise on overdrawn directors’ loan accounts which the company will have to account for to HMRC in addition to the sum advanced to the directors.
• These are known as section 455 charges which we deal with elsewhere in this guide.

Where the company is solvent and is not having difficulty paying its creditors, it can be reasonably expected that an overdrawn director’s loan account (provided it is authorised in accordance with its articles and any shareholders agreement) is permissible and is a mechanism by which directors are remunerated until dividends are declared at the year-end.

• An overdrawn director’s loan account can remain overdrawn for some years, subject to paying the Section 455 tax.
• Alternatively, it may be overdrawn and repaid at the end of each year and no Section 455 tax becomes due and provided the company continues in that way then there is little risk to directors.

How should directors treat an overdrawn directors loan account?

Whether the director’s loan account is overdrawn or in credit, the treatment of the director’s loan account is largely a matter for the directors to address in accordance with their director’s fiduciary duties.

Solvent companies

Where the company is solvent then their duties are to the company’s shareholders (which often are the same individuals) and therefore there is little for the directors to worry about.

Companies with financial difficulties

However, where the company faces either a risk of insolvency, in need of company rescue or becomes insolvent then directors must tread very carefully.

• Where the company enters into an insolvency process the directors will have to repay any overdrawn directors’ loan accounts and where the directors seek to declare dividends to set off the directors’ loan account balances, then the company must be solvent to enable such dividends to be declared (which is usually impossible pre-insolvency).
• A company may have distributable reserves entitling a director to declare dividends but solvency is not always determined by the existence of distributable reserves. Under Section 123 of the Insolvency Act 1986 a company can be wound up as insolvent where a debt in excess of £750 exists and has not been paid. This is the definition of insolvency by virtue of an inability to repay a company’s debts.
• Companies which are either dormant or have little cash funds available often face this risk and so may have huge distributable reserves but are unable to declare a dividend sufficient to offset an overdrawn director’s loan account.

How we can help

At Francis Wilks & Jones we can assist and advise you on a company’s solvent position and how to best reduce the risk of any overdrawn director’s loan account being reclaimed or how you can best address how you exit the risk of repayment.  Alternatively, we frequently act for directors in defending claims for repayment of a directors loan account.

Claims by liquidators and administrators

A director’s loan, whether recorded within your books or records or not, is an account of what a director owes a company. 

• Where a director has withdrawn such a loan lawfully, in accordance with the company’s articles of association and any shareholders agreement, and with the consent of shareholders, then it is a director’s loan.
• Alternatively, where a director’s loan has been drawn without the above statutory prerequisites (and subject to certain exceptions which your legal advisor can outline to you) then a director may be liable for unlawful drawings from the company. 

A director’s loan can be one properly recorded and accounted for, or it can be one construed – on the basis that the directors/shareholders agreed such payments which may have been wrongfully accounted for (or not accounted for at all).

Claims for repayment

It is these circumstances that we often find Directors facing a claim for repayment of a director’s loan by an appointed Liquidator(s).

• Liquidators are appointed by creditors of a company which has been placed into liquidation either by a creditor via a Court Order (referred to as a winding-up order) or;
• where the directors of a company consider that the company cannot continue trading and voluntarily call a meeting of creditors to place the company into a creditors’ voluntary liquidation.

For a creditors voluntary liquidation, the appointed liquidator has often been an advisor to the director(s) and the company beforehand. 

What happens after a liquidator is appointed?

Once appointed, an Insolvency Practitioner is legally required to prioritise creditors’ interests and this could extend to seek payment of any equitable  compensation from directors for breaches of the director’s fiduciary duties or a simple claim against directors for repayment of their director’s loan account balance.

• Where the loan account balance has been  accounted for legitimately within the company (which we address elsewhere in this guide) and where the section 455 tax has also been accounted for and paid then the balance repayable can be reduced by legitimate means.
• Where the sum claimed is a culmination of drawings or other payments to a director which were not in the company’s interest, then this director’s loan balance claim may come out of the blue and as a complete surprise to the director(s).

Defences to claims by liquidators

Regardless of how it is set out, where a director’s loan balance is claimed then the director may

• have claims that they have not been paid, or
• they have unpaid declared dividends or
• they have unpaid expense claims or
• there might be other reasons to provide the director with a defence (some of which are not always that obvious).

In such circumstances there may well be defences which can either eliminate or greatly reduce the sum sought by the liquidator.

Liquidator duties

Ultimately, if a company goes in to liquidation, a liquidator has a duty to creditors and not the company’s former director(s) (despite any good relationship beforehand).  Whilst a liquidator may present a solution before their appointment, if directors face the above risks, then this solution will change to a different type of problem later.

A liquidator, if he cannot recover such directors loan account balance, may issue proceedings against the director.  There are several factors affecting whether such a claim is issued, and for directors it is best to focus on these factors, as well as potential defences, before proceedings are issued.  Taking this approach could alleviate the risk and, in all likelihood, will leave you in a better position.

If matters are left, and a director faces a judgment liability for part or all of the debt, then added to this will usually be judgment rate interest (currently 8%) plus the liquidator’s legal costs in getting to this point.  Both of these could seriously inflate the original claim by 2=3 (or more) times.

The best recommendation is to get advice early. At FWJ we have a dedicated team defending claims by liquidators and administrators, including DLA claims.

Claims by HMRC

Directors loans are a record of the balance of funds paid (as cash or as the equivalent of cash) to a director which do not comprise remuneration.

• Remuneration of course, is taxable under the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”).  If no tax is paid, it is not remuneration and should be paid back.
• If alternatively, directors (as with many SMEs) incur expenses in carrying out company business – then it is not unreasonable for this to be paid back by the company.  Whether it is directly involved in a company’s operations or selling the company’s goods or services or even networking efforts, all of these are properly recognised by HMRC as legitimate company expenses.

However, HMRC is also conscious of the ability of company to abuse such arrangements and use a director’s loan account to avoid the usual tax liabilities they would face under ITEPA.  A typical example is where directors loan funds from a company and then any directors loan account balance (if one is recognised) is written off.

To avoid this risk, which would be almost impossible to police across all of the companies in England and Wales, HMRC has for some years taxed any directors loan not repaid by the end of the 9-month period after the company’s financial year-end (at which date a tax, referred to as section 455 tax, must be paid alongside the company’s corporation tax).  We address this tax elsewhere in this guide.

This is of course a company liability and failing to recognise the director’s loan or failing to account for the section 455 tax can lead to HMRC penalties and interest and, ultimately, a personal liability against directors.

There are several ways this can happen and, briefly, we summarise these below:

• If the company is placed into liquidation, an appointed liquidator could pursue a director for the unpaid director’s loan.

• Where a director’s loan is written off, this may be defined as income and HMRC may pursue the company for such unpaid PAYE and NIC on such sums.

• Where a company fails to pay the PAYE liability on any payment which may be defined as income, the PAYE liability can be transferred to the director in certain very specific circumstances (although this is unusual).

• A director can be liable for the National Insurance unpaid on any sums paid to them via a Personal Liability Notice.  See our separate page which addresses Personal Liability Notices.

• A director may face a claim for breach of their fiduciary duties (either by an appointed liquidator or administrator or by the company acting via its other directors, particularly where there is a director/shareholder dispute) to HMRC as a creditor of the company or for the conflict caused by allowing their personal interests to take priority over the company’s interests.

• HMRC may pursue a director personally for failing to account for a director’s loan as income in their tax return (or even if they have not filed a tax return).

Whilst HMRC itself does not have any direct powers against a director of a limited company in England and Wales, its enforcement powers against the company will ultimately lead to a director being pursued for such losses.

As is always the case, these matters are better addressed earlier rather than risking potential future (and far more expensive) complications.

Claims by fellow shareholders

Running a company is not easy – there are the competing needs of selling the business’ goods or services, the requirement to achieve growth by marketing to new potential customers, the necessary regulatory obligations (which differ between different businesses), the requirements to constantly ensure there are enough funds to pay the rent, staff and direct business costs and the need to constantly retain accurate books and records and particularly the current important of seeking advice and documenting decision-making (to protect yourself as a director).

In addition to all the above, as a director you want an income.  Is that too much to ask?

• However, a director’s remuneration is not always straightforward and the director/shareholders often prioritise growth at the beginning and – in addition to any capital invested – do not pay themselves a salary nor draw dividends (which can only be drawn where profit exists – this guide deals elsewhere with the benefits and risks of a director taking a salary as opposed to dividends).
• The answer to this difficulty is often that directors draw director’s loans in the hope of the business improving and profits being utilised to repay those loans (usually by way of a dividend).

Sometimes, as often happens in companies, one director may have more access to the company’s financial records – dealing with orders and turnover, regularly speaking to the accountant (who is solely responsible for filing documents at Companies House) and making decisions on payments – which are often not described as directors’ loans.

Often, particularly where there is a dispute, a director may be moving assets (usually money) out of a company and changing how such transactions are described in the company’s accounts.

In all these circumstances, there may be claims for repayment of such sums either as a breach of fiduciary duty or as a director’s loan.

Important to sort out shareholder disputes quickly

Where such shareholder disputes arise, they are often best resolved early on. 

• They can continue and fester to the detriment of all or both parties (and the company and its business). 
• This can form a contractual claim via a shareholder agreement or it could form a claim by the company, either now or at a later date. 

At FWJ we have a dedicated shareholder dispute team which is very experienced at resolving shareholder disputes, including over directors loan accounts.

Director removal

Where the accused director is involved in such a dispute, they may be subject to director removal by other shareholders and later pursued by the shareholders acting through the company for repayment of the balance owed on the directors’ loan account).

Where the shareholders do not (or cannot) remove the director – usually where the other shareholder(s) hold 50% or less or the company’s ordinary share capital, then the Companies Act 2006 provides relief to those minority shareholders, who may issue derivative proceedings which may comprise any legal claim but, in this situation comprises a claim for repayment of the director’s loans account).

Derivative proceedings

The advantage of derivative proceedings is that subject to a minority shareholder(s)  obtaining leave from the Court to continue the claim, the company should pay all associated legal costs. 

This creates complex issues with the accused director then being on the back foot,  because they will be defending the claim in their personal capacity – the company will not be permitted to pay their legal fees.  And for the minority shareholder(s) they then face the benefit of not having to pay their legal costs, which are indemnified by the company(s) in question.

For director’s loans, such proceedings are often not complex.  But it is vital when drawing such directors’ loans lawfully that all shareholders agree this.

Claims for Director disqualification

Abuse of a director’s loan account can be a ground for director disqualification. But the issue of director’s loans can be complex and there are often grounds to defend these types of claims – either in disqualification proceedings or claims by liquidators or administrators.

Our team has been defending directors from disqualification since 2002. Let our experts help today.

What is director disqualification?

Director disqualification is a process which seeks to ensure companies are run properly, with due regard to the ethical manner in which business should be carried out in the UK and the process of taxation in respect of profits generated in business. The purpose of this is to maintain confidence in the structure of our economy so as to maximise the prospects of all businesses being successful.

• Where a company, or rather its directors, act contrary to this social and legal framework, then directors are liable to be disqualified from continuing to act as a director, thus removing from them any future benefit of the limited liability status under which companies operate.
• One of the most important features of our economy is the need to ensure taxation of all business profits, without which we would not have the stable environment in which businesses can operate in the UK.

Directors loan accounts: what are they?

Directors’ loan accounts are, as they say, accounts which reflect the amount drawn by directors as a loan.

A directors loan account, for many small companies, is not something usually entered into deliberately (but see below the statutory requirements) and are often a mechanism for accounting for sums drawn by directors but not as salary, remuneration, expenses, dividends or any other category of legitimate drawing.

Quite often for small companies, they represent the amount “taken” by directors, sometimes for their personal needs and without accounting for tax.

Directors loans: legal requirements

Legally, a director’s loan is not available to a director unless s/he has the agreement of creditors (who may authorise a directors loan above a certain sum).

• For some companies, the directors and the Shareholders are the same individuals and so getting this agreement is straightforward. However for other larger companies this may not be so simple and, without such consent, the taking of a director’s loan is effectively theft.
• Where consent is not given, it is possible to seek such consent retrospectively so all is not lost if the formalities are not followed through until later (although we would never recommend adopting such an approach).
• A directors loan is not an alternative form of income – it is repayable and, if not repaid at the year-end, will have to be accounted for to HM Revenue & Customs, who will apply a loan tax on the amount outstanding on the directors loan at the year-end.

For more details on the taxes due on director’s loans please see elsewhere in this guide

Misconduct which can lead to disqualification

Where a directors loan is used as an alternative form of income, there are a number of areas of misconduct.

• Firstly, such behaviour could comprise tax fraud as it would effectively be disguised remuneration where remuneration normally subject to PAYE/NI is “disguised” as a loan, to avoid such a liability.
• Often the loan is never repaid or written off via accounting entries (which are relatively easy to instigate in a small company) and thus the company is permitted to participate in a tax avoidance scheme.
• For many small companies, the directors loan is unauthorised by shareholders and may not be accounted for in its books and records – it is merely something which is constructed to account for unauthorised drawings from the company by directors.
• As a side issue, if a company has not accounted for the tax due on the director’s loan account balance as at the year-end, then this in itself can form grounds for a finding of misconduct.

Disqualification claims

A disqualification claim will often be brought against a director on various grounds ranging from the misuse of his/her position to draw funds from the company (as directors loans), the effect this has on the company’s solvency and the failure to account for the tax liability arising on such loans.

• however, it must be remembered at all times that these are loans and remain assets repayable to the company. This obviously depends on the lending director’s personal financial circumstances, but a loan should not devalue a company or reduce its assets.
• quite often, sums drawn from a company are mistakenly considered to be loans where we find, very frequently, that a lot of drawings tend to be expenses incurred by a director in conducting the company’s business;
• accordingly, it is vital that a director maintains good accounting records so as to be able to demonstrate what such payments reflected (as otherwise the Secretary of State may jump to the conclusion that they are loans to directors).

Where confronted by allegations of the use or misuse of a directors loan account, a director needs to strongly consider the quality of the company’s books and records, any missing expense paperwork and his/her salary entitlements (including any salary as yet undrawn) all of which may be relevant to their defence of a disqualification claim.

At Francis Wilks & Jones we have considerable experience of director disqualification matters, dealing with representations on the above and many other issues that you may not have previously considered, as well as acting for directors in litigated disqualification proceedings.

Please call any member of our director disqualification team for a consultation today. Alternatively please email us with your enquiry and we will call you back at a time convenient for you.

Importance of proper accounting records

For directors of limited companies and partners of LLPs, running a business is complicated to organise and complicated to stay on top of. 

As with all commerce, these difficulties in running your business are not helped by the existence of fraud and therefore legal restrictions and requirements including the requirement to maintain accurate accounting records.

Importance of keeping accurate records

For a directors loan account, director and shareholders might be drawing funds for the business on day-to-day basis, both using their own personal credit cards, drawing cash from the business account and refunding themselves for payments made, often without the directors’ own knowledge. The only way of understanding what is happening is by referring to the accounting records maintained.

This is almost, in our experience, the downfall for a director personally.

Common mistakes

We commonly see the following scenario:

• Directors often incur expenses and do not maintain a record of such expenses. 
• Then they seek reimbursement, which they pay to themselves.  Then sometime later there is either an audit or the preparation of financial accounts and a “guess” may be made as to what goes where. 
• Then (likely a further period later) a third party reviews the company records and decides that without any accounting records, that the director in question has been randomly drawing money for his own benefit, without an entitlement and without accounting for any tax liability.

Eliminate risks with proper records

These risks can all be eliminated by tight and distinct records of company expenses, salary and other payments to a director.  The director in question is protected and no complaint can be made if you can point to a record which supports why you were paid.

Without such records, or with poorly maintained records, then there are considerable risks.

Claims by liquidators

In our experience these issues cause the most problems for directors in claims by liquidators or administrators for recovery of sums paid to directors.  If a director has not maintained proper records, they may not be able to explain the payments and then may have to pay such sums back (which can over a period of time extend to a large sum of money).

Even time does not assist a director, as company assets paid to the director are held on trust and therefore exempt from limitation rules. 

Disclosure of directors loans in company accounts

The Companies Act 2006 (as amended including in respect of LLPs) provides extensive regulation of how a company is run and how its constitution should be managed.

Duty of proper disclosure

A company is required to also have an Articles of Association, which can be tailored to address precisely how affairs within the company are governed, and a shareholders agreement which further sets out the agreement or current and future shareholders as to their objectives for the company.

There are additionally accounting rules as to how financial information should be correctly presented.

• Included within these obligations is a requirement as to the information to be provided in the financial accounts prepared for the company, which can be found at Sections 409-413 of the Companies Act 2006 (as amended).  These comprise the notes that should be affixed to financial accounts, to explain certain statements or values.
• Section 413 of the Companies Act 2006 addresses the requirement to provide information within the notes to the company’s accounts, of any loans or advances granted by a company to its directors.  
• In a similar fashion Section 412 of the Companies Act 2006 requires similar information about directors’ remuneration paid by the company and the financial reporting standard FRS102 (which is a financial reporting standard required for the purpose of preparing accounts for companies incorporated within the UK and the Republic of Ireland) provides a definition of related parties which fall within the requirements of the Companies/Partnerships and Groups (Accounts and Reports) Regulations 2015 (“the 2015 Regulations”) which require information to be provided on related party transactions.

In summary, the above requirements are intended to address any risk of company assets being removed out of a company to its managers and/or owners without following the appropriate processes (e.g. by way of salary, dividends, expenses or otherwise).

It is vital that a company and an LLP discloses all of the loans to its management within its accounts such as to have full transparency as to the risk that the management remove funds without a public account (to protect stakeholders, which may include creditors where the company is insolvent) and without an account for the tax that should be due on such transactions (to protect the treasury).

Without such disclosure then a director may be found liable to repay compensation to a company, on the basis of a breach of a non-fiduciary duty.

Directors’ right to the loan money from the company

A director of a limited company (or a partner of an LLP) does not generally have any right to loan money from their company.

Shareholders decision to agree directors loan.

This decision rests (in a similar form to all substantial transactions relating to company assets) on the shoulders of shareholders.

• Ordinarily, a company enters into agreements with directors for their remuneration, which may be via a service level agreement providing salary or the director may choose instead to receive his/her remuneration via the status as shareholder in the company (i.e. by taking dividends).  
• Often it is the case that shareholder agreements are entered into for such purposes and to oversee the various interests of the director shareholders, as some may be more closely involved in the company’s finances (and therefore a tighter restriction may be required).
• A director also generally does not have any statutory right to demand remuneration from a company, subject to what the company’s articles of association and the shareholders agreement (which takes priority) state.

But ordinarily the directors and shareholders may be the same individuals and may agree to draw loans, which legislation permits.

Director loans under £10,000

However, as set later in this guide, with directors’ loan accounts under £10,000, a director generally does have the ability to loan funds from a company under £10,000 without shareholder approval.

Often this will be with the approval of all the directors (if there is more than one director) and as and where necessary for the director’s own personal needs.

Repayment of directors loans

As with all directors’ loans these are repayable and – if not repaid – subject to section 455 Taxes at the year-end (which we address elsewhere in this guide); so a director needs to be careful that their aggregate loan never rises above this sum because, even if taken in increments, the total sum loaned must never exceed £10,000 subject to what the company’s articles of association and any shareholders agreement states.

Payments to family members or associates

Directors loans to related parties need to be considered carefully.

Family relationships

Often a company is run with family members involved to enable a director to distribute their wealth amongst their family.

This may well be done in companies where there is more than one director, all with spouses, children and other associates or relatives who are deemed to be working  within the company.

Are the family members actually fulfilling a role?

Provided such associates and relatives are fulfilling an occupation within the company then that is fine and any remuneration paid to them will be remuneration for their services (subject to any income tax payable on such payments).

• However, where payments are made to associates and relatives who are either named as employees (but who are not acting as employees) or where the payments are just made generally to them (perhaps in addition to any salary), then there is a high risk that this will be considered to be a director’s loan.
• A director’s loan encompasses all monetary or non-monetary advances for the benefit of the directors and/or related parties and we refer elsewhere int his guide to disclosure of directors’ loans in the company’s accounts and how related parties are defined under Financial Reporting Standard 102.
• If payments to such related parties, being associates and relatives (or indeed to the directors themselves), are not accounted for as directors’ loans, or the directors’ loans are not accounted to HMRC for the purpose of the Section 455 tax charge, then these payments can comprise unlawful drawings from the company.

What happens on insolvency?

Similarly, where a company is placed into an insolvency process (be that the appointment of an administrator or the appointment of a liquidator) then such payments may be recoverable either from the directors  or from the associates and relatives directly.

• A recovery from directors can comprise equitable compensation sought by the company (acting via its appointed liquidators or administrators) for a breach of the directors’ fiduciary duties or an unlawful drawing in making such payments to associates and relatives
• this is particularly where the payments are not accounted for as directors’ loans and/or are not accounted to HMRC, to whom a fiduciary duty is owed as a creditor of the company where the company is insolvent.

If instead the payment was to a related party, being an associate or relative, an appointed administrator or liquidator could instead seek to press charges against the associate or relative directly as a preference or transaction at an undervalue under the Insolvency Act 1986.

These provisions are comprehensive and can be quite onerous against the related party, who are often targeted where they hold distinct identifiable assets such as property.

Accordingly, a payment to an associate or relative risks placing a significant liability on both the recipient and the director on whose behalf such payments or transfers of assets were made.

Director loans under £10,000

Under the relevant legislation (the Companies Act 2006) the value of a directors’ loan should be the monetary value or the value of any such transaction which is an equivalent value in monetary or similar monetary terms.

• Quite often a directors’ loan may be the guarantee of a directors’ personal liability or it may be a non-monetary asset or the benefit of an arranged contract.  This can also extend to payments or benefits provided to related parties.
• All of these transactions can comprise directors’ loans which are subject to the same taxation or regulatory restrictions as a conventional director’s loan would be.

Authorisation of loans

Under the Companies Act 2006 (as amended) a directors’ loan must be authorised by members, or shareholders, of the company.  The equivalent in an LLP would be the partners.

If shareholders have not authorised such a transaction, then the director is effectively drawing sum unlawfully and in breach of Section 847 of the Companies Act 2006 for unlawful drawings from the company.

Exceptions for loans under £10,000

However, as set out elsewhere in this guide we address exceptions to the restrictions placed on directors loan accounts, which include small loans under £10,000.

• It is often the case that such small loans to owner-manager directors are also exempt from seeking shareholders’ approval by the company’s articles of associated – the reason being that many transactions can potentially be described as directors loans and, as well as the administrative inconvenience, it could potentially disrupt the day to day business if a shareholders resolution has to be constantly sought.
• Where directors and shareholders are the same individuals, this will not normally cause an impediment.
• However, where there is a dispute between directors and shareholders, then the directors should be careful not to draw directors’ loans above the limit imposed by the company’s constitution.
• Where a directors’ loan is drawn above this sum but in contravention of the legal requirements, then there are civil consequences such that a company can seek restitution of any such sums drawn or paid to the director and such rights may exist long after the director has left the company.

As with all business dealings, it is essential that a director documents both the reasons for any payments to themselves, ensures that adequate books and records are maintained and ensures that properly minuted approval is sought from shareholders (where required) and is retained for his/her personal records.

DLA’s and your accountant’s recommendations

Directors of limited liability companies and partners of LLPs in the UK are subject to numerous legal, regulatory and financial requirements.  

Not all directors can be experts on these matters and often it is essential for a director to be closely aligned with their professional advisor, which is usually their accountant, who can assist them with all aspects of the company’s affairs in respect of financial and taxation concerns.

The financial year for a business

Many companies operate on the basis that the business runs during the year and then their accountants tidy up the books and records at the financial year end.  Quite often many directors will draw funds from a company and then seek their accountant’s assistance to work out how to account for such funds at the year end.

Remuneration – PAYE & dividends

Of course, where a director is being paid remuneration on a PAYE/NIC basis, it is always recommended that the company reports such remuneration to HM Revenue & Customs monthly so that the appropriate deductions can be made on a month-by-month basis in a timely manner as required by HMRC.

• The benefit of salaries (from a director’s perspective) is that it is guaranteed income which in most scenarios cannot be reclaimed from that director (although where excessive there may be a question).
• However, PAYE for employees salary is subject to a higher tax threshold and therefore a director has to weigh up the balance between drawing their remuneration as a salary or as a dividend.

Importance of a professional accountant

It is therefore critical to ensure that your business has an independent accountant advising it and that the accountant’s advice is appropriate and correct. Regulated accountants are expert professionals in their field and will be able to guide a director through both the tax and regulatory atmosphere prevailing as at the time of the company’s business operations.  At FWJ we work with a range of trusted accountants we have known for over 20 years.

• Advice on taking a director’s loan and drawing remuneration at the year end is subjective – a company which is in a loss-making scenario which endlessly draws directors’ loans for the benefit of directors will suffer numerous problems.
• The risk of repayment is certainly a longer-term risk but there are also tax liabilities arising at the end of every financial year if a directors’ loan has not been repaid.
• The advice received from your accountant should be considered and is dependant on the business and the owner-manager’s business strategy.

Understand your director fiduciary duties

A director must always be aware that one of their statutory directors’ fiduciary duties to independently consider any professional advice received (including from the company’s accountants) and simply relying on an accountant without any thought or consideration is a breach of a director’s duties.

If things go wrong, you cannot simply blame the accountant and indeed (as well as the statutory duty imposed on directors to independently consider such advice) there is legislation further protecting accountants from being blamed for directors’ decisions.

Accordingly, it is very important that a director both listens to and considers an accountant’s recommendations.

Director loan accounts and e-shares

Directors’ loan accounts are very flexible vehicles which are used by directors to assist in short-term personal funding needs and to account for any liabilities arising between the directors and the company. For close companies, i.e. ones owned and controlled by five or fewer directors who are described as “participators”, the use of a directors’ loan account is extremely commonplace.

Detailed guidance on Close companies can be found in the HMRC internal company taxation manual CTM61505.

E share schemes

In recent years tax avoidance schemes have arose whereby shares are issued which are only part-paid by the shareholders in whose name they are issued.

• Normally such E-shares (as they are described) are issued in close companies where the directors and shareholders are identical and also hold the E-shares in identical proportions.
• Upon issue of the E-shares it is often the case that a very small percentage of the nominal share value (commonly 1p in the pound) is paid to the company, with the balance not called up by the company from the director(s).  
• Whilst such share capital is never called up (i.e. a payment demand made by the company) such a call or repayment demand will be immediately made upon the company being placed into insolvency, as this is a principle of limited companies (that the liability of the owners is limited to the capital value of their shareholding, and nothing more).
• However, for a company that continues to trade (or are dormant) then the uncalled capital is not called up or repaid and often it is the case that the company either records the shareholdings as called up but not paid (as a debtor) or as not called up (in respect of the amount unpaid).  This is usually 99% of the value of the e-shares issued.
• In consideration for the obligation to pay these E-shares the company and the director/shareholders often enter into a contract by which the company pays a sum equal to the obligation to subscribe for the E-shares, which may in the future be called upon (but rarely is).
• It is often the case that a director has an overdrawn directors’ loan account which is cleared by the issue of these E-shares in this way. So in summary a director can seek a director’s loan paid to him/her either in a single year or over a period of years and then seek to issue E-shares to annul the overdrawn directors’ loan account liability, remove the liability to repay the directors’ loan and remove the Section 455 charge that would otherwise be payable as at the year end for the company (or seek to reclaim such sums from HMRC, if the section 455 tax charge has already been paid).
• In consideration of this the director has a theoretical liability to pay the balance due on E-shares issued but not called upon.

There remain other accounting treatments which could create further complexity regarding E-shares but as of writing we have not seen any such complexities arise and therefore have chosen not to address it in this article. However, if you do require assistance with E-shares or any connected issues relating to your director’s loan account then please do contact us.

Risk of credit balances on director loans

A credit balance on a director’s loan account is where you lend the company money and the company owes money to the director. It is a liability to a creditor in the financial accounts and accordingly will be a sum that the company must repay.  This can include interest.

How does a credit balance arise?

Such a credit balance may arise from the initial capital funding provided by directors or it may arise as a result of undrawn remuneration, dividends or otherwise.

• Note that even where directors’ loan accounts credits are created by undrawn remuneration, where a PAYE/NI charge exists then an account for such taxation must be made to HMRC whether or not the actual underlying sum, or net payment, has been remitted to the director or instead credited to his/her loan account.
• It is often the case that a director will have a credit directors loan account balance due from the company and that director is therefore an unsecured creditor and should be treated in the same way as other unsecured creditors.

Is the amount immediately payable?

Where such a credit balance exists then repayment of such sums will depend upon the company’s financial circumstances. If the company is solvent and trading then the director does not have to pay concern to other unsecured creditors’ interests and the company may repay the director’s loan account balance due to him.

What if the company is struggling?

However, where the company is having trading difficulties, in a company rescue situation or may be having difficulties paying unsecured creditors as and when they fall due, then under the Insolvency Act 1986 the company may be insolvent and therefore any repayment of the director’s loan account could (should the company be subsequently placed into an insolvency process) be either a preference payment (as defined by the Insolvency Act 1986) or a breach of the director’s statutory fiduciary duties to the company under the Companies Act.

What if the company goes bust?

If a company does not pay back the credit on a directors loan account balance, but then falls into an insolvency process, then the credit balance on the director’s loan account will rank equally to other unsecured creditors and will participate in any distribution to creditors in a similar capacity to other creditors of the company.

• As is often the case in insolvency, the pence in the pound paid to unsecured creditors of the company is often quite low and therefore a director who seemingly advanced money for the company’s benefit and thought they were going to be repaid the credit balance, may find that they received none or only a very small part of it if the company is placed into an insolvency process.
• We refer elsewhere in this guide on the difference between directors’ loan accounts as opposed to capital investments where we set out how a director’s loan account can be more beneficial to investing funds and holding your investment in the reserve of a company.

Often the risks and benefits are dependant (as always) on the company’s success, the strategy of its owners and the way in which directors loan accounts are managed.