For many directors and small business owners, using a Directors’ Loan Account (DLA) is a common and efficient way to manage their personal drawings from their company throughout the year.
They get the cash they need quickly and the overdrawn balance is usually cleared later in the year through a dividend or bonus payment, before the end of the financial year.
Obviously there are tax consequences associated with DLAs that your accountant will make you aware of such as a Benefit-in-Kind charge for interest-free loans over £10,000 (calculated using HMRC’s official rate) or the s455 tax charge if the loan isn’t repaid within nine months of the year-end.
But the situation changes if a company goes into liquidation with an overdrawn DLA.
In this situation, the liquidators are legally obliged to ask for repayment of the outstanding balance because it is an asset of the company which they are charged with collecting for the benefit of creditors.
What does the liquidator do?
Repaying a DLA could seem worrying but it doesn’t automatically mean immediate recovery action or financial hardship will follow. A liquidator has a legal duty to protect the interests of creditors but they are pragmatic and will always look to work constructively with directors.
The considerations for directors with overdrawn loan accounts in a liquidation will center around the terms and availability of repayment.
Liquidators will assess the financial position of directors to better help repayment options. Rather than pursuing aggressive legal action, they will most likely offer flexible repayment options or other sustainable repayment plans.
If repayment is avoided or arrangements entered into in bad faith then as well as the risk of the liquidator pursuing legal action, there will be tax implications to consider too.
Beyond the s455 tax, which would see a 32.5% temporary charge if the DLA is not repaid within nine months of the company’s financial year-end. There could also be some benefit-in-kind charges too.
If the loan is written off as bad debt by the liquidator then the outstanding loan amount may be taxed as income for the director, at the higher rate.
The Quillan v HMRC Case: A Key Insight
A recent First Tier Tribunal (FTT) case has given some important recent insights into the tax implications of an outstanding DLA during liquidation.
The central issue in Quillan v HMRC revolved around whether a director’s loan was released or written off during the liquidation of Mr Quillan’s company (BOH Investments Ltd), which would trigger an income tax charge for Mr Quillan as the director.
At the time BOH entered liquidation, Mr Quillan owed the company approximately £440,000. Some repayments were made but around £382,000 remained outstanding when the company was dissolved.
The liquidator of BOH Investments did not formally write off the loan in order to retain the right to restore the company and pursue repayment if Mr Quillan later acquired the means to repay the debt.
HMRC argued that, for tax purposes, the DLA was written off. They referred to guidance suggesting a loan is considered written off if the liquidator isn’t actively pursuing it. Mr Quillan maintained that no formal release or write-off had taken place.
The Tribunal ultimately found in favor of Mr Quillan.
They considered the definition of “written off”, noting it isn’t strictly defined in tax legislation. The FTT concluded that the DLA had neither been released nor written off.
The reasoning highlighted that the liquidator’s reports and correspondence didn’t indicate a formal agreement to release the debt and there exists a formal process that liquidators would follow if a loan were to be written off, which wasn’t undertaken.
The tribunal specifically noted that the liquidator deliberately didn’t proceed with a formal write-off process precisely so they could retain the right to pursue the debt in future. As a result of this finding, Mr Quillan wasn’t subject to income tax on the outstanding loan amount of £382,000.
Other potential liabilities
While Quillan v HMRC offers some clarity regarding the income tax treatment of a DLA that isn’t formally written off, another recent case serves as a reminder of other potential personal liabilities directors can face in liquidation.
In Strange v HMRC, the sole director and shareholder was found personally liable for unpaid company National Insurance Contributions (NICs) that had been declared but not paid. Given recent increases in employers’ NIC rates, this case highlights other areas directors should be mindful of.
Chris Horner, insolvency director with BusinessRescueExpert, said: “An overdrawn DLA in liquidation means that the liquidator has to seek repayment.
“The approach they take is usually pragmatic and will focus on discussions and feasible repayment options rather than be immediate aggressive action.
“While personal liability is a risk, it can be mitigated especially if the loan was taken in good fatih.
“Tax implications, particularly if the loan is written off, are significant and should be considered but the Quillan case demonstrates that a deliberate choice by the liquidator not to formally write off a debt can prevent an income tax charge for the loan holder.
“The economy is going to remain turbulent so it’s important that directors understand and are aware of these potential issues with DLAs as quickly as possible.
“Advice and planning are the key to navigating any complex DLA situation.”
This is why we offer a free initial consultation to any director who wants to get ahead of any potential complications in an insolvency.
Administrations, CVAs or voluntary liquidations all have advantages depending on the unique circumstances facing each business but talking them through now, before they’re entered in to will give directors all the information and details they need to make the most effective decision for them.
Get in touch to arrange yours at a time when it’s most convenient for you.