Overdrawn directors loan accounts: Don’t forget tax!

A director’s loan account (DLA) documents the transactions that occur between a director and a company. It includes salary, dividends, expenses, director’s personal bills paid for by the company and reimbursements.

If the DLA becomes overdrawn by more than £10,000 and the company is a close company, there is a potential for a benefit-in-kind charge on the director and a Class 1A National Insurance charge for the company.

There are, however, some exceptions to this including:

• If the loan is used for a ‘qualifying’ purpose such as buying an interest in a partnership
• If the director is charged interest by the company

For these loans, there is normally no interest charged however the director will be taxed on any interest that would have been payable if they had borrowed from another source. Sometimes though it can be cheaper for the director to just pay the benefit in kind charge and the company to pay the NICs.

To replay an overdrawn DLA, it is preferable to use dividends from the company so that no NICs are payable. If there are insufficient accumulated profits though, and a dividend is still paid, this may be deemed to be ‘illegal’ and so a salary or bonus should be used.

If the overdrawn DLA is not repaid with 9 months and 1 day after the accounting year end then a charge, taxed at the higher dividend rate is payable. This is refundable after the loan has been cleared or written off.

If the loan is repaid within the required 9-month period, this charge is not physically paid, although it is still declared in the tax return.

If the loan is written off, then it is liable for income tax and Class 1 NICs with the NICs being deducted via payroll and the tax via self-assessment.

It is likely that under Making Tax Digital, overdrawn DLAs and illegal dividends will be an area that HMRC will focus on as the 3 monthly returns will make them highly visible. Thus, it is important to be aware of the regulations and implications surrounding DLAs in order to prevent action from HMRC.

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