Spring 2010
Director's Loan Accounts - beware of the pitfalls!
Owner managed businesses use a director’s loan account (DLA) to record a number of transactions and these can include:-
- Cash drawn by the director on account of salary, dividends and expenses.
- Other drawings by the director for example personal bills paid by the company.
- Net amounts of salary and dividends due and not physically paid to the director.
- Expense re-imbursements for example company bills paid personally by the director.
Normally a DLA is in credit and this is important because overdrawn DLAs:-
- Are Illegal under s. 330 of the Companies Act 1985 if they exceed £5000.
- Can attract a Corporation charge of 25% under s.419 of the ICTA 1988 which is repaid when the DLA moves back into credit.
- Can be classed as a benefit in kind to be included in a P11D and therefore attract income tax and NIC if they exceed £5000 for any length of time during the accounting period.
- Have to be disclosed in the accounts which may restrict the company’s ability to obtain credit.
Leaving aside their legality and the disclosure and tax issues, overdrawn DLAs can cause serious problems for the director if the company becomes insolvent and ceases to trade. I can illustrate this more easily by sharing with you a very common reason for an overdrawn DLA this being excessive drawings resulting from the decision to take dividends in lieu of salary.
Directors of owner managed businesses are often advised to take dividends instead of salary so as to avoid paying 12.8% (13.8% next year) employers NIC. The dividend is calculated at the end of the year when the accounts are produced but in the meantime, because he has to live, the director will draw an amount probably each month of approximately 1/12 of the anticipated annual dividend. These payments are posted to the DLA which come the end of the year may be overdrawn. The dividend is then calculated and declared and posted to the DLA which should move back into credit.
However problems arise for the director if the dividend, which can only be paid out of distributable reserves, fails to match the director’s drawings and the DLA remains overdrawn. The position can worsen if the company moves into insolvency caused by a downturn in business and by cash flow problems as a result of the director being unable to repay the amounts he has drawn to enable the DLA to move back into credit.
If the company then goes into insolvent liquidation the liquidator has a statutory duty to pursue the director for the balance of the overdrawn DLA. Adjustments may be made if for example the director, post liquidation, has to make payments to creditors such as the Bank under personal guarantees but in general the liquidator has little scope to compromise. The liquidator will also look back at any dividends paid to ensure that the company had sufficient distributable reserves and that the proper procedures were followed.
These potential problems can be avoided if directors monitor the company’s trading performance and consult their accountant if results are not meeting expectations. The advice they receive may be either to reduce the level of drawings or convert part or all to salary. If the company appears to be insolvent the directors should consider seeking the advice of an insolvency practitioner as there are a number of remedies and rescue procedures available even if the DLA is overdrawn at that stage. For example it may be possible to come to an arrangement with creditors using the company voluntary arrangement (CVA) procedure.
As in the case of all struggling businesses the solutions available are greater in number and simpler to implement if the problems are addressed at an early stage.
Simon Parker is a chartered accountant and licensed insolvency practitioner.
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