7 Ways to Grow Your Small Business in 2025: Part 1 – Client Retention
14th January 2025Overdrawn Director’s Loan Accounts: A Practical Guide
As a small business owner and company director, managing cash flow is crucial. But what happens if you accidentally take more money out of your company than you’ve put in? This is where an overdrawn director’s loan account (DLA) comes into play. It can be worrying to be told, or to realise, that you have an overdrawn DLA – however with the right information, and the correct actions, it can be overcome without grinding your business to a halt.
In this guide, we’ll explain what an overdrawn DLA is, how it happens, the tax implications, and the options available to resolve it.
What Is an Overdrawn Director’s Loan Account?
A director’s loan account (DLA) is a record of transactions between you (as the director) and your limited company, outside of salary, dividends, or expenses. If you withdraw more from the company than you have put in—and don’t repay it—your DLA becomes overdrawn.
How Do Director’s Loan Accounts Become Overdrawn?
There are several ways this can happen:
- Taking money from the company for personal use without it being a salary or dividend.
- Poor cash flow planning leading to unintentional withdrawals.
- Paying personal expenses from the business account.
- Declaring dividends without sufficient profits to cover them.
- Not recording transactions correctly, leading to unexpected balances.
Consequences of an Overdrawn Director’s Loan Account
If your DLA remains overdrawn at the company’s year end date, it can trigger several tax and financial consequences:
1. Section 455 Tax Charge
If the overdrawn balance is not repaid within 9 months of the year-end, HMRC applies Section 455 tax, a charge of 33.75% on the outstanding amount. This is payable by the company but can be reclaimed when the loan is repaid.
2. Benefit in Kind and P11D Reporting
If your loan exceeds £10,000 at any point during the year and you don’t pay interest at HMRC’s official rate (published and updated on their website here), it must be reported as a benefit in kind (BIK) on a P11D form for the tax year. This means:
- The company pays Class 1A National Insurance (13.8%) on the benefit.
- You, as the director, will have extra personal tax to pay.
3. Personal and Company Risks
- If your company goes into liquidation, an overdrawn DLA is treated as a debt that must be repaid.
- HMRC can reclassify the loan as salary if it believes the company is avoiding PAYE and National Insurance contributions.
How to Overcome an Overdrawn Director’s Loan Account
If you have an overdrawn DLA at the end of your company financial year, there are several ways to resolve it:
1. Repay the Loan from Personal Funds
- You can pay back the amount you owe directly from personal savings or income.
- If repaid within 9 months of year-end, Section 455 tax does not apply.
2. Declare a Dividend
- If the company has sufficient retained profits, you can declare a dividend to cover the loan amount. (This will then be taxed via your personal tax return.
- If declared before the year-end, the loan never becomes overdrawn in the accounts and you’re all set to go.
- If declared within 9 months of the year-end, it prevents the S455 tax charge. (This can be beneficial if you want to spread out the dividend over different tax years)
- Be mindful of personal tax liabilities on dividends (8.75% basic rate, 33.75% higher rate, 39.35% additional rate). Company year ends often don’t align with the tax year, and so this needs to be taken into consideration.
3. Write Off the Loan
- The company can choose to write off the loan, treating it as income for the director.
- The amount is taxed as a dividend on your personal tax return.
- If you’re also an employee, HMRC may treat it as salary, meaning PAYE and National Insurance apply.
4. Pay the S455 Tax and Leave It Outstanding
- If you can’t repay the loan, your company can pay 33.75% S455 tax on the amount.
- This tax is reclaimed when the loan is eventually repaid, but it’s a short-term cash flow hit.
Preventing Future Overdrawn Loan Accounts
To avoid this issue in the future, consider these strategies:
- Improve business profitability so there are enough funds for dividends or salary.
- Monitor your director’s loan account regularly to ensure it stays in credit.
- Plan for taxes and dividends so you don’t accidentally take out more than you should.
- Review your personal budget so you can reduce your drain on company funds – even for a short period.
- Use an accountant to help you structure your withdrawals efficiently.
Final Thoughts
An overdrawn director’s loan account can lead to costly tax implications and financial stress. However, there are several solutions available, from repaying the loan to planning dividends properly. The key is early action and careful planning. This is an area of financial management that benefits significantly from forward planning – not burying your head in the sand.
If you need advice on handling an overdrawn DLA, get in touch with an accountant who can guide you through the best options for your situation.
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