Can Directors Loan Accounts be Reclassified as remuneration in Administration or Liquidation?
In a recent High Court case, the answer was no and that attempting to do so could lead to penalties for the directors. Our Insolvency Practitioners comment.
In a recent article, we have commented on the dangers of overdrawn Directors’ Loan Accounts (DLAs) when a company enters into Administration or Liquidation. Insolvency Practitioners are duty bound to scrutinise Directors’ Loan Accounts, which, if overdrawn, can lead to insolvency claims against the directors as well as director disqualification investigations. In this article, we look at a recent judgement from a High Court case, which investigated the issue of whether DLAs could be reclassified as remuneration. The case highlighted the risks to directors in trying to do so.
The details of this High Court case
The case, Jones v The Sky Wheels Group Ltd (2020), examined whether monthly drawings, that were initially taken as a DLA (with a view that a dividend would be declared at a later point in time), could be reclassified as remuneration.
Two company directors, who had taken out loans during the year, and which were due to be discharged by the payment of a dividend at the end of the year, fell into a dispute which halted the dividend payments. One of the directors attempted to have the drawings reclassified as remuneration instead, and thus avoid having an overdrawn DLA.
The Court did not accept this argument as to do so would admit to HMRC that the information provided to them was incorrect in the first place. The Judge, Lord Justice Snowden, pointed out that under the arrangement of paying off the debt of an overdrawn DLA though a year-end dividend…
“…. the periodic drawings are not declared as remuneration for the purposes of PAYE and NIC. Instead the directors and shareholders benefit from the more favourable tax treatment accorded to dividend payments.
In light of the manner in which such arrangements are presented to HMRC, in general terms I do not consider that such periodic drawings can simply be re-characterised as remuneration as and when it might suit one of the recipients so to contend. Or at least that cannot be done without acknowledging that the manner in which they had previously been disclosed to HMRC had been incorrect, with all the consequences in terms of the payment of additional tax, interest and penalties that this might entail.”
Comment from Andrew Brown, Barrister
Andrew Brown is a specialist Insolvency Barrister from Radcliffe Chambers. He commented on the judgement:
“There is nothing wrong with such an arrangement [declaring a dividend to clear an overdrawn DLA] provided that, (1) the company is solvent, and (2) there are distributable reserves at the end of the accounting period to pay sufficient dividends to offset the DLA liability.
However, if there are insufficient distributable reserves (or the company is insolvent), then the company is not lawfully able to declare dividends, and the liability under the DLA must remain on the books, which will be an obvious risk to the director if the company demands repayment of such or it goes bust and a liquidator steps in to demand repayment.
Further, if the company is already insolvent, then such interim payments might attract claims of misfeasance for breach of fiduciary duties where the directors are paying themselves benefits in lieu of protecting the interests of creditors. Further, any formal attempt to waive liability for the DLA by the company (acting through its directors) might attract an antecedent transaction claim such as under s.238 Insolvency Act 1986.”
He went on to point out because DLAs must be reported in statutory end of year accounts and also in corporate tax returns, which must be signed by directors for submission to HMRC, for directors to then try to recategorize such payments as remuneration rather than loans, then their…
“…. signatures on official documents declaring the payments as creating a personal debt owed to the company will be strong evidence against them, and if they resile on such signatures they might be placing themselves in a tricky position regarding how they reported those payments to HMRC.”
Our comment as Insolvency Practitioners
We are seeing an increase in enquiries from struggling companies where overdrawn Directors’ Loan Accounts are an issue. Anecdotally, it is commonly accepted in the Insolvency profession that between 75% and 80% of business insolvency cases involve overdrawn director loan accounts.
An overdrawn Directors 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 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 (as the above case shows), and if the Director loses, they typically end up paying legal costs as well as the claim – sums which can be hugely expensive.
Antony Batty, Licensed Insolvency Practitioner at our London office points out:
“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: