While directors’ loan accounts are permissible loans from a company to its directors, they can become thorny problems during annual tax returns or in cases of insolvency.
Many directors wish their company could simply write off the overdrawn loans, but what are the laws around this?
Can I Write Off an Overdrawn Director’s Loan Account?
You can write off an overdrawn director’s loan account. However, the director will incur a tax liability on the written-off amount when declared on their personal tax return, in accordance with Section 415 of the Income Tax (Trading and Other Income) Act 2005[1]Trusted Source – GOV.UK – Section 415 of the Income Tax (Trading and Other Income) Act 2005.
If the company becomes insolvent and goes into liquidation, the appointed insolvency practitioner will treat the loan as a company asset. They will seek to recover this money for the benefit of the company’s creditors.
How to Write Off a Director’s Loan Account (DLA)
Writing off an overdrawn director’s loan account (DLA) involves several key steps and tax implications:
The company must officially declare and document that it will not collect the debt.
HMRC typically treats the written-off amount as a type of earnings for the director, similar to a dividend, but without requiring company profits.
The company will need to pay Class 1 National Insurance Contributions (NICs) on the written-off amount.
Directors must declare the written-off amount on their personal tax return, which will impact their tax liability.
The company cannot reduce its corporation tax liability by the amount of the loan written off.
Given the complex tax implications, it’s crucial to consult with a qualified accountant to ensure accurate record-keeping and compliance with UK tax laws.
Disclosure of an Overdrawn Director’s Loan Account in the UK
UK law, specifically Section 413 of the Companies Act 2006[2]Trusted Source – GOV.UK – Section 413 of the Income Tax (Trading and Other Income) Act 2005, requires disclosure of overdrawn director’s loan accounts in company financial statements. Key legal requirements include:
The balance sheet lists the loan amount under “current liabilities” if repayable within a year or “long-term liabilities” if repayable after one year.
Financial statement notes must provide additional details such as interest rate, repayment terms, and any guarantees made.
The company must also disclose the loan in its Corporation Tax return using supplemental sheet CT600A.
Accurate disclosure is crucial for compliance and transparency. Failure to do so can lead to penalties from HMRC and potential legal issues.
Written off Directors’ Loans in Liquidation
When a company goes into liquidation, the insolvency practitioner (IP) is responsible for maximising creditors’ returns. As such, they will examine the company’s financial affairs in detail.
If the IP discovers a directors’ loan, even if it was formally written off in the previous accounting year, they will likely consider it an asset of the company that needs to be recovered for the benefit of creditors[3]Trusted Source – GOV.UK – Section 212 of the Insolvency Act 1986.
However, most IPs take a pragmatic approach to recovery. If you are unable to repay the full amount of the loan, they will usually be willing to reach a reasonable settlement. This is because the alternative would be to pursue bankruptcy proceedings against you, which is typically more expensive and time-consuming and may result in a smaller return for creditors.
Here are some additional things to keep in mind:
If you are a director of a company in financial difficulty, it is important to seek professional advice from a qualified accountant or insolvency practitioner such as ourselves. We can help you understand your options and minimise the risk of personal liability.
If you are unable to repay a directors’ loan, it is important to be transparent with the IP and cooperate with them. This will increase your chances of reaching a favourable settlement.
If bankruptcy proceedings are started against you, you will be disqualified from being a company director for a period of time.
FAQs: Writing Off Overdrawn Director’s Loan Accounts
Is there a time limit for writing off a director’s loan?
No legal time limit exists, but HMRC may question write-offs that occur shortly after the loan was taken out.
Can a company write off only part of an overdrawn director’s loan?
Yes, a company can choose to write off a portion of the loan. The tax implications will apply only to the written-off amount.
How does writing off a director’s loan affect the company’s profit
The written-off amount is not tax-deductible for the company, so it doesn’t reduce the company’s taxable profits.
How does writing off a director’s loan impact other shareholders?
Writing off a loan could be seen as giving preferential treatment to one shareholder-director, potentially leading to disputes with other shareholders.
References
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
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