Risks of Living Off An Overdrawn Director’s Loan Account
The risk of living off an overdrawn director’s loan account (“ODLA”) is that it is not money earned like a salary; it is a loan that has to be paid back. If a director finds they cannot pay it back, they could be in for a shock. If a director operates an ODLA without applying a cautious awareness then the risk is it becomes the norm and grows year on year, becoming unmanageable.
It is so important that a director fully understands what a Director’s Loan Account (“DLA”) is that goes overdrawn and the tax consequences.
If liquidation arises, then there is no putting it off for another day, as the company has ceased trading, so the liquidator will need to realise it reasonably fast and not keep a liquidation open for years and years eating with costs eating away at any recoveries for creditors.
What Is An Overdrawn Director’s Loan Account?
A director’s loan account records transactions between a director and their company that are not salary, dividends, or expense reimbursements. If a director withdraws more money from the company than they have put in or are entitled to, the account becomes “overdrawn.” It is an asset of the company that the director owes.
Why Directors Use DLAs To Take Money
This typically happens when directors want to extract funds without running payroll or declaring dividends, often due to temporary tax benefits, cash flow issues, or even potentially when lacking formal accounting advice. Prolonged use of overdrawn DLAs to fund personal living can become a serious liability.
Risk 1: Tax Penalties From HMRC
One of the biggest risks is the tax treatment. HMRC imposes a Section 455 tax charge on overdrawn loan accounts not repaid within nine months and one day of the company’s year end. Currently, this is charged at 33.75% of the loan balance, which will restrict the availability of certain company funds as a result.
Additionally, if the ODLA exceeds £10,000 and isn’t charged interest at HMRC’s official rate, it may be treated as a benefit in kind, triggering both income tax for the director and Class 1A National Insurance for the company.
The risk is not just that of the company because if an ODLA is written off and treated as a dividend, then instead there is an income tax charge for the director under Section 415 of the Income Tax (Trading and Other Income) Act 2005.
Risk 2: Personal Repayment If The Company Fails
If the company goes into liquidation, an ODLA becomes an asset that the liquidator is required to try to recover. The director is personally liable to repay the outstanding balance due to the company. It doesn’t matter that the company has closed because you cannot close down the ODLA debt without repaying it personally.
This can come as a major shock, particularly if the director has been relying on the company to support their lifestyle without realising they owe it money.
Risk 3: Increased Scrutiny And Potential Misfeasance Claims
In insolvency, the conduct of directors is reviewed. If it is found that you’ve been extracting significant sums from the company without by way of loans instead of receiving a salary properly, the liquidator could bring a misfeasance claim against the director. This is a civil action to recover losses caused by wrongful conduct, and it could result in you being ordered to pay compensation to the company personally, sometimes with interest and costs.
Risk 4: Difficulty Accessing Credit or Starting a New Business
If a director ends up with a County Court Judgment (“CCJ”) or Individual Voluntary Arrangement (“IVA”) because they could not repay the ODLA, this could affect your ability to get credit, mortgages, or set up another business in the future. Directors with a history of financial mismanagement may also face disqualification proceedings.
