Overdrawn Directors Loan Accounts

How to account for an overdrawn director’s loan account: The companies act governs overdrawn loan accounts which can be subject to tax and NI.

Going Overdrawn

Direct cash transfers from the company to a director, paying a director's personal bills or the reimbursement of expenses which are not "wholly and exclusively"  for the purpose of the company’s trading are charged to the director's loan account.

Detailed records must be maintained, showing the dates and values of individual entries into a director's loan account. Overdrawn loan accounts that exceed £10,000 (i.e. from 2014; £5,000 prior to that) at any point during the year will attract a "cash equivalent" benefit in kind in respect of interest. This will be the case even if the loan has been repaid or gone into credit by the financial year end.

Commercial Risks of Overdrawn Loans

A bank, investor or creditor is likely to be alarmed by directors' overdrawn loan accounts with significant value relative to the working capital of the business. This would especially be the case if financial support is being sought.

If large overdrawn loan accounts cannot be substantially reduced or eliminated altogether, their value might then be disregarded when assessing the equity or the working capital (and therefore the liquidity) of the company. Were that to result in a working capital deficit, the business could then be regarded as being insolvent for all practicable purposes.

Corporation Tax Act section 455

The allowable period between the end of the financial year and paying corporation tax is nine months and one day. If at the end of the financial year a director has an overdrawn loan account, they have this period of grace to repay it.

If that has not happened the company becomes liable to pay 25% tax on the value of the overdrawn loan account under the UK Corporation Tax Act; section 455. This applies to all overdrawn loan accounts; including those of £10,000 or less. The company can recover this tax in line with repayments. Claims for recovery of the tax must be made within four years of loan repayments or six years for repayments made on or before 31st. March 2010.

If it is subsequently established that the declaration of an overdrawn loan account was made late, HMRC would be likely to levy financial penalties. Repayments can be made either by the director concerned paying back the amount owed to the company or by issuing dividends to reduce or clear the overdraft.

Overdrawn Loan Account as a Benefit in Kind

A director's overdrawn loan account is regarded by HMRC as an interest bearing benefit in kind.

If the director is not paying interest on the overdrawn loan account, an official rate of interest will be assessed by HMRC (4% for 2012 / 2013) as a benefit in kind. In either the case the director will be required to pay personal tax on the interest. This does not apply however to overdrawn loan accounts that remain at or below £5,000 throughout the course of the year.

Taxing the Benefit in Kind

If a director's overdrawn loan account balance varies in the course of the year, HMRC will calculate the director's tax liability on its cash equivalent interest benefit by a daily averaging method. In the example below assume the following:

1). The overdrawn balance b/fwd from the previous year is £10,000.
2). The financial year starts 1st. April 2014
3). Beneficial interest is assessed by HMRC at 4% p.a.

  Borrowed Repaid Balance For no. of Days Beneficial Interest
1st. January  b/fwd. 0 10,000 90 99
31st. March 1,200 0 11,200 62 76
1st. June 900 0 12,100 121 160
30th. September 2,000 0 14,100  62 96
1st. December 0 6,000 8,100  30 27

The total of the interest benefit in kind for the year is £458. If the director pays interest to the company at or above the official rate on the loan, the benefit in kind does not arise.

If the balance of the loan account had remained at or below £10,000 throughout the year, tax on interest as a benefit in kind would not have arisen. In this example however the £10,000 limit has been exceeded during the year so tax on a benefit in kind applies. Just one day in excess can trigger a charge.

The company is also required to pay employer's class 1A national insurance on interest assessed by HMRC when overdrawn loan accounts have exceeded £10,000 at any point during the year, or where interest is charged and then simply added to the loan amount instead of it actually being paid by the director.

Authorising Loans to Directors

All individual borrowings from the company by a director must be authorised by the board and minuted as such.

Borrowings above £10,000 must be approved by the shareholders. In both cases the terms and conditions of the loan must be stated in the minutes, scheduling how and by when it is to be repaid.

Personal Tax on Loans

However overdrawn loan accounts come about, their assessment for the directors concerned will depend on HMRCs view of them.

If a loan remains unpaid for more than a year for example or if the withdrawals show a regular pattern, the director could then face tax being assessed on them as earnings. Both the director and the company would then also be liable for national insurance contributions on the assessement.

Disclosing Overdrawn Loan Accounts

These form part of balance sheet current assets. A summary of each director's loan account, showing borrowings, repayments and the year end balance is required to be specifically disclosed in the notes to the accounts. It is a breach of the companies act to consolidate overdrawn loan accounts under a general heading such as sundry creditors.

Apart from the auditors statement, loans are required to be declared in the corporation tax return CT600. This is has to be done even where a loan has been repaid.

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