Directors be Vigilant! The additional tax charge for an un-repaid Director’s Loan Account is 33.75%

Understanding a Director’s Loan Account and your Liabilities, pre and post liquidation is vital – Bethan Bryant explains in this video.

(Insolvency Manager, Bethan Bryant.)

In September 2022, we reported on how common overdrawn Directors’ Loan Accounts are in insolvency cases – anecdotally the number is generally considered to be between 75% and 80% liquidations. A Liquidator is obliged to try and recover these unpaid Directors Loans, which are usually repaid by the directors personally. But what about unpaid Directors Loans when a company is not insolvent? Under these circumstances, the additional tax charge is a hefty 33.75% for 2022/23 up from 32.5% in 21/22. In this article, we look in more detail at this charge and also recap on an overdrawn Directors’ Loan Account at liquidation.

When is tax due on a Directors Loan Account?*

The key thing to remember with a Directors Loan is that the money still belongs to the company and, if it is not repaid, HMRC will want the tax that is due on it. After all, such loans have not been subject either to personal or company tax. So, when is tax due on an overdrawn Director’s Loan account?

The answer is that unless you pay back a Director’s Loan within 9 months and 1 day of the year end, then the additional Corporation Tax on the outstanding amount is currently 33.75%, up from 32.5% in 2021/22. This 33.75% is repayable to the company by HMRC if/when the loan is repaid to the company by the director. It is also worth noting that there might be personal tax to pay at 33.75% of the loan amount if a Directors’ Loan is not repaid. This tax is not repaid by HMRC if/when the loan is repaid.

By way of illustration, if a company has taxable profits of £20,000, currently its corporation tax bill will be £3,800 (£20,000 x 19%). However, if during the same accounting period, the Director’s Loan Account was overdrawn by £30,000 (and remained unpaid for 9 months and 1 day after the years end), then the additional tax due will be £10,125 (£30,000 x 33.75%) meaning the total Corporation tax bill for the period will be £13,925. The £10,125 can be reclaimed if, at some point in the future, the director repays the loan, or the company decides to write-off the loan to the director.

As with all things tax, writing off a Director’s Loan does not end there. If a Director’s Loan is written off by the company, then tax must be paid on the loan by the director as dividends. Under these circumstances, the director will need to include the written off loan on their annual Self-Assessment tax return and pay tax personally at the dividend higher rate threshold of 33.75%.

(* Please note: although this is our understanding of the tax legislation, we are not tax advisors and Directors should take professional advice from their accountants in relation to any tax consequences of an overdrawn loan account.)

Overdrawn Directors’ Loan Accounts and liquidation – a recap

Although the above figures relate to solvent companies, overdrawn Directors’ Loan Accounts are often a sign of underlying financial difficulties. If a company becomes insolvent and enters a liquidation process, the situation changes.

An overdrawn Director’s Loan Account happens when there is a balance owed from the Director to the company at liquidation. Once a Liquidator is appointed, the Liquidator is obliged to try and recover any such amount that is owed by the directors, which is treated as a debt that is owed to the company. Such Liquidators’ Claims are usually paid personally by Directors. When disputed, cases can and do end up in Court, and if the Director loses, they typically end up paying legal costs as well as the claim – sums which can be hugely expensive.

The rules as they stand stipulate that in the time-period leading up to insolvency and a Creditors’ Voluntary Liquidation, the focus switches away from Directors towards Creditors. So, declaring a dividend in the lead up to liquidation, as an attempt to cancel or reduce an overdrawn Director’s Loan Account, for example, is no solution at all.

What about Illegal Dividends?

Dividends are only payable from profits, and yet we regularly see Directors paying Dividends as insolvency approaches and even when insolvent.

Liquidators can, and do, seek to reclaim such Dividends from the Directors personally, because such Dividends are illegal. Financial recovery action is part of a Liquidator’s remit.

The on-going financial effects of the Pandemic, coupled with the current high inflationary pressures and rising energy costs, are likely to be prevalent here because sums that directors typically take out of the company to pay for non-business personal expenses are charged to the Director’s Loan Account. Then, in order to redress the resulting overdrawn position, a Dividend is declared to repay the sums due before the company’s Accounts are finalised. However, if the profits are not there to allow for the Dividend, then any such Dividend will be illegal and will be investigated at liquidation. Clearly, with many businesses suffering right now, it is likely we will see an increase in such investigations.

Under these circumstances, more directors are likely to face financial recovery action at liquidation.

What can directors do?

Hugh Jesseman comments:

“Where liquidation is the only available option, it is vital that businesses and directors are well advised by their accountants and referred to us at an early stage, so that they do not fall into the traps of overdrawn directors’ loan accounts and paying illegal dividends that can end up with expensive, time consuming and stressful consequences.”

If you are concerned about the financial position of your company and are facing insolvency, please contact us or contact one of our offices:

Also, K&W Recovery, trading as Antony Batty and Company, Thames Valley:

Our Insolvency Practitioners will take you through your options step by step and will advise you of the best one to take under the prevailing circumstances.