What happens to a Director’s Loan Account in liquidation?
Firstly, if you are reading this article and are worried that you have a director’s loan, we don’t want you to panic, there are many directors in the same position. What’s more, there are options for you even if your business ends up in liquidation.
Even though there’s a legal separation between a director and a company, in the case of director’s loans, these can’t simply be written off if a company is experiencing financial hardship.
So what happens to money owed by a director to the company during liquidation? In this article, we’ll tell you more about what’s likely to take place.
What is a Director’s Loan Account (DLA)?
Directors will usually take money from their company in the form of a salary, dividends [if the company makes a profit] or a combination of both. Sometimes a company may need a cash injection, in which case a director may decide to loan the company money. This results in a directors loan being in credit. Or a director may need a short-term personal loan which it can borrow from the company. Both transactions are known as a director’s loan.
These transactions between the company and the director must be recorded on the Director’s Loan Account to ensure transparency. In addition, if there’s more than one director within the company, each director must maintain their own DLA.
If a director has taken too much money from the company, their DLA is overdrawn. If the director has loaned the company money, it’s in credit. In an idea world a director should aim to keep the DLA at zero or in credit.
Although borrowing money from the company is not best practice, the reality is that it happens and it is very common that a director of a business in the UK will have had an overdrawn directors loan account at some stage. Having an overdrawn directors loan account is not necessarily a problem as long as the money is repaid back to the company.
Make sure you keep adequate records
At the end of the company’s financial reporting period, any money the company owes the director or vice versa must be shown in the company’s accounts and reported to HMRC, as there may be tax liabilities for both parties.
If a director owes the company money, the director has nine months and one day after the company’s accounting period ends to pay the company back. If the loan isn’t paid back in full, the company will be liable to pay S455 corporation tax on the outstanding balance. The director will also have to pay tax through their self-assessment tax return. The current rate for S455 tax is 32.5% or 25% for loans made before April 2016.
The company can reclaim S455 corporation tax. However, this can be a bit of a drawn-out process. The director who has enjoyed the benefit of a loan from the company is not eligible to claim back any of the tax it has paid to HMRC.
What happens to a DLA in liquidation?
When a liquidator is assigned, there job will be to scrutinise the director’s loan accounts to look for any transactions which may have jeopardised the company’s financial future. As a result, running an overdrawn DLA up to and as a company enters liquidation can lead to serious personal financial difficulty.
If the liquidator finds that a director borrowed money from the company, which it could not financially support at the time, there may be severe repercussions, including:
- Repaying the loan, regardless of your personal financial position (which introduces the risk of personal bankruptcy)
- The liquidator beginning court proceedings for the monies owed
- A 2-15-year disqualification as a director if misconduct is uncovered
- Criminal prosecution if illegal activity is found.
A problem arises for a director if they place their company into liquidation and there is an overdrawn director’s loan account. This loan sits as an asset of the company and the insolvency practitioner appointed to deal with the liquidation of the company has a duty to recover the loan back from the director and distribute it to the creditors of the company. When it comes to having an overdrawn directors loan account In liquidation it’s critically important that you understand what your position is, this means knowing what your overdrawn directors loan stands at and what you will do about it when the company goes into liquidation. This is not something to deal with down the line and please do not think that the insolvency practitioner will not find out about it or that they won’t check.
Start by taking a look at your last set of accounts and look for the section that says ‘debtors’, this is who owes the company money. It’s here that an overdrawn director loan could be published , it could also appear further down the accounts as a directors loan. This is a good starting point for you. Don’t rely on the ones at companies house as these accounts may be shortened and don’t show you the full picture, check the last set of full accounts that were sent from your Saint Accountant.
Next you need to work out what there up to date figure is, generally accounts are submitted for the previous year, so your directors loan account could of gone up or down depending on how much money you have taken from the company or paid back since your last set of accounts.
You should look at all the transactions from the date of the accounts up until now, working out all the money paid from the company to the director, this will leave you with a figure. Then you subtract anything that has been paid through the PAYE scheme, any personal spending for the benefit of the company, you will need to be able to prove this, with receipts and invoices etc, and any money that you have paid back to the company. This should leave you with a worse case final balance of your directors loan. We strongly recommend that you get some help doing this and we are happy to assist with no obligation so you understand your issue up front with no surprises down the line.
An insolvency practitioner is there to represent the interest of creditors in a insolvency procedure. It’s their job to investigate a directors loan account and then recover money from the director so it can be distributed to creditors. Although initially an insolvency practitioner may be demanding that you have to pay all your directors loan back in one go, many will come to some sort of settlement with you, dependant on your personal financial position and your ability to pay. In most circumstances you will be able to agree a deal were you repay a percentage of your overdrawn directors loan back. This figure will be based on things like, do your own a property, how much equity you have in the property, are you married, do you have any investments and do you have any disposable income.
One thing is for sure, you will be able to agree a better settlement with an insolvency practitioner if you do it before you appoint them. So many directors spend months worrying before they make an enquiry, when they finally speak to someone, they can almost be in a rush to get a liquidation over and done with. Our advice here is very simple, slow down and be willing to take the time to understand all the costs that you will incur by going into liquidation. An extra few days working out exactly what your directors loan account stands at and negotiating a settlement will not make much of a difference.
Need more advice?
If a business is flourishing, director’s loans aren’t necessarily an issue, especially if they’re managed correctly. However, they can become a complex area of business as a company declines, so it’s essential to seek advice as soon as possible.
This article was written by Chris Worden on behalf of 1st Business Solutions.
If you’re concerned about any of the issues raised in this article, get in touch for some free impartial advice.
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