An overdrawn Director’s Loan Account (DLA) occurs when a director of a company withdraws more money from the business than they have put in or is owed to them. In essence, the company is lending money to the director.
In practice, overdrawn DLAs tend to occur when the director has taken more money from the company than it can declare in dividends (i.e.: they have withdrawn more from the company than it has made in profits).
While this is allowed, there are strict tax rules and potentially expensive consequences.
Tax Consequences of an Overdrawn DLA
- Corporation Tax (Section 455 Charge):
- If the loan balance at the company’s year end date is not repaid within 9 months and one day of the year end date (e.g.: year end 31 December, loan must be repaid by 1 October), the company must pay a 33.75% tax charge on the overdrawn amount (as of the current rates).
- This tax is reclaimable when the loan is repaid or written off, but it takes many months or even years to recover this.
- Benefit-in-Kind (BIK):
- If the loan exceeds £10,000 at any time, it is treated as a ‘beneficial loan’.
- The director must either pay interest on the loan at 2.25% (2024/25 tax year) OR they will be assessed as having a Benefit in Kind equal to the deemed interest at 2.25%.
- The director must pay income tax and the company must pay Employer’s NI on the deemed interest.
- Loan Write-Off:
- If the company writes off the loan, it’s treated as income for the director and subject to income tax and NICs.
- Personal Liability:
- If the company goes insolvent while the DLA is overdrawn, the director may be held personally liable to repay the loan.
Steps to Manage an Overdrawn DLA
- Repayment: Repaying the loan within the 9-month deadline avoids the Section 455 charge. This can be done by declaring (but not paying) a dividend from the following year’s profits. This can lead to increased personal tax bills. Also it is easy to get into a cycle of using the following year’s profits to clear the DLA, but then not having enough profit to cover the amounts drawn from company in that year thereby creating a new DLA. It is very easy to create a never ending cycle of DLAs. Also there are rules in place to prevent a director repaying the DLA with cash and then taking another loan shortly after (so getting their cash back)
- Dividends or Salary: Declaring dividends (if there are sufficient profits) or additional salary can offset the loan, but these are subject to income tax and NICs.
- Avoid Personal Use: Keep personal withdrawals separate from company finances to avoid overdrawn accounts.
- Plan Ahead: Regularly review the DLA to ensure it doesn’t become overdrawn or is managed effectively.
Key Considerations
- Overdrawn DLAs can attract scrutiny from HMRC, particularly if loans are frequently taken and repaid just to avoid tax charges.
- It’s essential to consult an accountant or tax adviser to understand the implications fully and take the most tax-efficient approach.
- As mentioned above, dealing with an overdrawn DLA can be both very expensive and inefficient from a tax perspective.
- Most overdrawn DLAs arise because the director(s) unwittingly draw more from the company than it can pay in dividends because they do not have regular, up to date accounts to assess profitability and dividend availability.
If you have or have had an overdrawn DLA problem simply due to not having regular, up to date financial information our monthly or quarterly digital accounting solution could be just what you need. We will prepare your accounts on a regular basis to the same standard as at the year end so at any time you will exactly how much can or can’t be taken as dividends. If we spot there is an overdrawn DLA during the year we can offer advice and help to deal with this quickly and in a tax efficient manner so it does not become an expensive problem at the year end.
For more information about this please get in touch.
