Abuse of a Directors Loan account

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.  For a very simple explanation of the most common forms of taxation on a company please click here.

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 Directors 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 Her Majesty’s 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 click here.

Misconduct

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 now on 020 7841 0390. Alternatively please email us with your enquiry and we will call you back at a time convenient for you.