What happens if my Director’s Loan Account is overdrawn?

A director’s loan account (DLA) records money a director takes from or pays into their limited company that is not salary, dividends, or expenses. It effectively tracks the financial transactions between the director and the company.

If you take more money out of your company than you have put in, your director’s loan account becomes overdrawn. This means the company has effectively lent you money. While this might not seem like a big issue, it can lead to significant tax implications and additional reporting requirements if not managed properly.

This article explains what happens when your DLA is overdrawn, how HMRC treats it, and how to avoid unnecessary tax charges.

Understanding a director’s loan account

Your director’s loan account records transactions such as:

• Money you pay into the company (for example, startup funds or reimbursed expenses).

• Money you withdraw that is not salary, dividends, or a repayment of money owed.

When you owe the company money, the account is overdrawn. When the company owes you money, it is in credit.

How an overdrawn director’s loan occurs

A DLA becomes overdrawn when you withdraw funds from the company that exceed what you have put in. This can happen if you:

• Take drawings instead of salary or dividends.

• Withdraw money to cover personal expenses.

• Receive cash advances that are not repaid promptly.

• Take dividends before the company has sufficient retained profit.

In practice, an overdrawn DLA means you have borrowed money from your company.

HMRC’s view of overdrawn director’s loans

HMRC treats an overdrawn DLA as a loan to a participator (a shareholder or director). This has specific tax consequences under Section 455 of the Corporation Tax Act 2010.

If your DLA is not repaid within nine months and one day after the company’s accounting year-end, the company must pay a temporary Corporation Tax charge of 33.75% of the outstanding balance.

This charge is known as the Section 455 tax and is designed to discourage directors from using their companies as personal cash reserves.

Example

If your company’s accounting year ends on 31 December 2024 and your DLA is overdrawn by £10,000, the company must repay it by 1 October 2025.

If it is not repaid by then, your company will owe £3,375 (33.75% of £10,000) in additional Corporation Tax.

Once the loan is repaid, HMRC will refund the Section 455 tax, but only nine months after the end of the accounting period in which the repayment was made.

Interest and benefit-in-kind charges

If your loan balance exceeds £10,000 at any time during the tax year, HMRC treats it as a benefit in kind. This means:

• The company must pay Class 1A National Insurance on the value of the benefit.

• You, as the director, must pay personal Income Tax on the notional interest.

To avoid this, the company can charge you interest at HMRC’s official rate (currently 2.25% for 2024/25). If no interest is charged, the notional amount is treated as taxable income.

Repaying an overdrawn director’s loan

There are several ways to clear an overdrawn DLA:

1. Repay the loan personally:
   You can transfer the money back to the company from your personal funds.

2. Declare a dividend:
   If the company has enough retained profit, a dividend can be declared to offset the overdrawn balance. Be careful, as declaring dividends when there are insufficient profits can lead to further HMRC issues.

3. Write off the loan:
   The company can write off the loan, but the amount written off is treated as income for the director and taxed as a dividend. The company also loses Corporation Tax relief on the written-off amount.

Avoiding “bed and breakfasting”

HMRC discourages a practice known as bed and breakfasting, where directors repay a loan just before the nine-month deadline and then immediately withdraw similar funds.

If you repay more than £5,000 and withdraw money again within 30 days, HMRC treats the repayment as if it never happened, and the Section 455 charge still applies.

How to manage a director’s loan account properly

To stay compliant and avoid problems with HMRC:

• Keep accurate records of all transactions between you and the company.

• Review your DLA balance regularly, especially before year-end.

• Repay loans within the nine-month window to avoid the Section 455 charge.

• Avoid using the company as a personal bank account.

• Consult your accountant before taking large withdrawals or dividends.

Accounting and reporting requirements

When your DLA is overdrawn, it must be shown as an asset on the company’s balance sheet because it represents money owed back to the business.

It must also be disclosed in the company’s annual accounts filed with Companies House if it exceeds certain limits. Your accountant will ensure the correct disclosures are made and that any tax implications are reported in the company’s Corporation Tax return.

What happens if the loan is not repaid

If you fail to repay the loan and the company cannot recover the money, HMRC may treat it as an unlawful distribution or as remuneration, depending on the circumstances.

This could result in:

• Personal tax liabilities for the director.

• Additional National Insurance contributions.

• Potential legal action from other shareholders or creditors.

In severe cases, persistent misuse of company funds could even lead to accusations of mismanagement or breach of director duties under the Companies Act.

How accountants can help

A qualified accountant can help you:

• Track and reconcile your director’s loan account.

• Plan repayments or dividends to avoid Section 455 tax.

• Manage interest calculations for benefit-in-kind compliance.

• Ensure correct disclosure in your annual accounts.

• Deal with HMRC if the loan has triggered a tax charge.

They can also advise on the most tax-efficient way to extract profits from your business without creating loan issues.

The bottom line

An overdrawn director’s loan account is not unusual, but it must be handled carefully to avoid unnecessary tax charges and penalties.

If your DLA is overdrawn at year-end, make sure it is repaid within nine months to avoid the Section 455 Corporation Tax charge. Keep accurate records, monitor your balance regularly, and seek professional advice before taking further withdrawals.

By managing your director’s loan responsibly, you can stay compliant, maintain healthy company finances, and avoid costly complications with HMRC.