For directors of small businesses, managing their Director’s Loan Account (DLA) is just another routine part of running their business. 

Most simply, a DLA is a record of transactions between the director and the company that aren’t salary, dividends or expense reimbursements. 

There are several advantages to being able to easily access funds through a DLA but these can quickly become a personal and corporate liability if the account becomes overdrawn (owing the company money).

If your DLA is overdrawn or the company is facing financial difficulties then you need to understand three major areas of personal and professional risk.

The immediate tax traps of an overdrawn DLA 

Even if you remain solvent, having an overdrawn DLA can incur tax liabilities for you and your company:

  • Corporation Tax Surcharge (S455 Tax) 

If your loan isn’t repaid within nine months and a day following the company’s financial year-end then the company must pay a Corporation Tax surcharge on the outstanding amount. 

This charge (also known as Section 455 tax) is currently at 33.75%. The tax is generally refundable by HMRC if the loan is later repaid, released or written off but still represents a substantial immediate cost and compliance burden to the business. 

  • Benefit-in-Kind (BiK) Liability 

If the overdrawn DLA exceeds £10,000 and the company doesn’t charge interest at or above HMRC’s official rate of 2.25% (known as the “beneficial rate”), then the interest saving is treated as a Benefit-in-Kind (BiK). This benefit is then taxable personally as income which incurs income tax and potentially National Insurance Contributions too.

  • The Tax Bomb on Write-Offs

If the company formally writes off or releases the DLA debt then HMRC will immediately view this as income received by you without tax deduction at source. You must declare the full written-off amount on your personal Self-Assessment tax return which could incur significant tax.

The consequences of insolvency

If the company enters a formal insolvency process such as liquidation then an overdrawn DLA becomes more of an issue.

  • DLA is a Company Asset

When an administrator or liquidator is appointed, an overdrawn DLA is considered an asset of the company. The liquidator is legally mandated by a duty to creditors to recover this debt in full – personally, from the director. 

It then becomes their personal responsibility for repaying the full amount. If the liquidator has to pursue the debt using legal methods then the additional costs, fees and interests added to the original balance could quickly become substantial. 

  • Recovery Action Threatens Personal Assets

If the director cannot afford to repay the loan then the liquidator can take the following actions imperelling their personal finances.

These can include issuing statutory demands or initiating proceedings to secure a County Court Judgement (CCJ) against them; seeking charges on personal property and assets and in the most serious cases involving substantial debt pursuing personal bankruptcy or repossession of property.

Misconduct, Misfeasance and Director Disqualification 

If a DLA is poorly managed then it could be the trigger into a compulsory investigation into their conduct as a director. This could lead to accusations of misconduct if evidence is found such as prioritising repaying yourself or drawing money while the company was struggling financially. 

  • The Risk of Illegal Dividends

It’s a common method for directors/shareholders to clear an overdrawn DLA by declaring a dividend at year-end. However, dividends can only be declared if the company has sufficient accumulated distributable profits. If profits are insufficient then any dividend would be categorised as illegal or void. 

If the business subsequently enters liquidation, the liquidator will seek to recover all illegal dividends, making the director personally liable for their repayment.

  • Director Disqualification

Mismanagement of a DLA such as drawing funds when a company is already insolvent, failing to keep accurate records or attempting to write off debt before liquidation can all be part of a misfeasance investigation into directors. If misconduct is proven then directors can be banned for between two and 15 years in the most egregious cases.

The Path Forward – Advice & Negotiation

The first thing to do if you find yourself in this situation is to get some impartial, expert advice to mitigate the personal risk you face. Some other tactics to consider include:-

  • Prioritise record keeping – ensure you have accurate and up-to-date financial records showing every transaction. This is crucial for defending any claims, proving legitimate expense repayments and justifying offsetting balances. 
  • Negotiation is possible – It is possible to negotiate a compromise settlement with the liquidator based on your true ability to repay. Providing a clear Statement of Means (detailing all personal assets, liabilities, income and expenditure) helps the liquidator justify accepting a reduced amount, especially if the cost of litigation outweighs potential recovery. Reductions are possible if the director demonstrates a genuine inability to pay the full amount and engages with the process openly and honestly. 
  • Personal Insolvency Options – If your personal financial situation is severely compromised then engaging in a personal insolvency solution such as an Individual Voluntary Arrangement (IVA), can provide an orderly resolution to the DLA debt along with any other personal liabilities.

The moment a company enters liquidation, any DLA debt is prioritised for recovery. Taking control of your affairs and getting professional, impartial expert advice before this happens is the best way to safeguard your personal financial future and help the business before matters become irrecoverable.

Get in touch with us today to arrange a free initial consultation and discuss what you can do, depending on your circumstances.  The earlier you get advice, the more options you usually have.