What you really need to know about DLAs

If you’re a director and your business is profitable then borrowing money from it is a welcome perk.

But if things are not going so well and the business runs into financial difficulty then a Director’s Loan Account (DLA) could become a problem with financial and personal consequences. 

A company bank account can’t be treated the same as a personal one and the distinctions become clear when a company nears or enters an insolvency process such as administration or liquidation. 

Understanding the difference and mitigating the potential impact and safeguarding yourself is crucial so here are six essential things you need to know about how DLAs in insolvency are treated.

  • When does a Directors’ Loan Account become a problem?

A DLA isn’t just a loan facility, it’s a record of all financial transactions between a director and their business excluding regular salary payments and dividends. Any money taken from the company, or given to it, outside of these normal payments contributes to your DLA so the account can either be in credit (the company owes you) or debit (you owe the company, also known as being overdrawn). 

An overdrawn DLA is a fact of business life but if the company enters liquidation or administration, then it could become an issue depending on the individual circumstances. Directors have a grace period of nine months and one day from the end of the business’s accounting year to repay the DLA and avoid it becoming overdrawn for tax purposes.

Ignoring an overdrawn DLA can lead to negative consequences if ignored or avoided.

  • An overdrawn DLA is considered a company asset in insolvency

If a business enters a formal insolvency process then any overdrawn DLA will no longer be viewed as just an accounting entry; it will legally be seen as an asset of the company. The insolvency practitioner (IP) appointed to oversee the process has a statutory duty to identify and recover all company assets, including this, to repay creditors. 

This means that you are personally liable for the debt and could be pursued for the full amount of the loan. This could also escalate to include additional costs, fees and interest which could make the final bill substantially greater than the original amount owed.

  • Tax implications of an overdrawn DLA

HMRC have intensified their scrutiny of director’s loans in recent years, implementing strict rules and guidelines. If a DLA is not repaid within the nine-month-and-one-day repayment period then it can trigger tax penalties as a result. 

For loans exceeding £10,000, directors could be liable for both income tax and national insurance while the company would have to pay corporation tax (S455 tax) too. These accumulated tax bills will increase the original loan amount over time. 

If the insolvency practitioner decides to write-off the DLA as part of the insolvency process, the value of the write-off is considered to be personal income for the director, without tax deducted at source. This must be then disclosed on any individual Self-Assessment tax return or it could result in a large personal tax bill. However, it’s critical to note that if the DLA is compromised under a personal insolvency procedure such as an Individual Voluntary Arrangement (IVA), then no personal tax is payable on the written-off amount.

  • Legal consequences beyond repayment 

Beyond any outstanding tax liabilities and financial penalties, an overdrawn DLA can also lead to legal consequences for directors during insolvency proceedings.

Insolvency practitioners are legally mandated to investigate the financial management of the business and the conduct of its directors including decisions leading up to the insolvency. 

As part of their investigations they have to determine whether the money taken from the company was when it was solvent or if the actions directly contributed to the company’s failure. 

If misconduct is found and can be proven, directors can face:

  • Personal liability for company debts
  • Disqualification or banning from acting as a company director
  • In extreme cases, criminal charges if illegal activity is detected

It’s important to distinguish between DLAs and illegal dividends. While both involve money being taken from the company, dividends are a share of profits made by the business. If a company’s year-end profits are insufficient to cover dividends paid then those payments may be deemed illegal. In the event of a liquidation, the director would be personally liable for repayment and if they can’t be repaid then legal consequences such as disqualification could follow if they have been proven to have repaid themselves via DLAs ahead of other creditors, especially if the company was insolvent at the time. 

  • Negotiations

While ignoring an overdrawn DLA in liquidation can put personal finances in jeopardy, the insolvency practitioner in charge has wide discretion in commercial matters and decisions as they have a legal duty to maximise returns for creditors.

The ability to pay is the starting point for any negotiation and providing a Statement of Means will be effective here. It’s a document that details all assets, liabilities, income and expenditure and by demonstrating goodwill and transparency with the liquidator based on a genuine financial position could positively influence settlement for a lesser amount. 

Any negotiations might also consider the costs of litigation for the liquidator and pursuing smaller DLA balances may not be commercially viable. 

Other factors such as property interests can also strengthen negotiating positions by reducing the available equity and if there is any doubt or dispute about outstanding DLA balances then presenting evidence can also lead to reductions.

  • Advice is key

The best course of action for any director that thinks they might have difficulties dealing with an overdrawn DLA if their business has to go into an insolvency process is to get some advice first. 

We offer a free initial consultation for just such an eventuality and will be able to advise what options directors have both before and after insolvency. The earlier advice is sought and viable solutions implemented, the more choices they find they have to help themselves and their company. 

Directors have to constantly mitigate risks and navigate their business, taking difficult decisions and avoid taking wrong turns including handling issues with personal implications such as overdrawn DLAs and personal guarantees.

Once they fully understand their situation and all the potential variables, then they’ll be in a better position to make the decisive choices that will help them in the short and longer terms.