Written ByKeith Steven
Managing Director
Keith is the Managing Director of KSA Group Insolvency Practitioners which has been established for 25 years. The company has undertaken more CVA led rescues than any other firm. Read our case studies to see how.
An Overdrawn Director’s Loan Account happens when a director owes the company money. This comes about when the company makes profits and the accountants advise on saving tax and keeping National Insurance at low levels, by paying directors a small salary but the company doesn’t have requisite reserves. Normally, directors take drawings every month from the reserves of profits in the past and current months but the problems start when the company stops making profits.
Usually, at the end of each month, quarter or year, the board vote on paying dividends to the shareholders. This way the drawings are cancelled and the dividends are voted through to cover the drawings.
Such an account is not too bad, so long that you can afford to repay it and keep track of the transactions. It becomes more of an issue when the business starts to perform poorly…directors can even end up with severe personal liability problems.
All accounts filed at Companies House should refer to any overdrawn current accounts as loans to the director concerned. You must try to get any loan paid back or reversed in subsequent periods as HMRC will tax YOU PERSONALLY on a fairly penal rate if you do not. When the director’s loan account becomes overdrawn, it is classed as a company asset.
To avoid the account fitting the ‘overdrawn’ category, the loan must be paid back within 9 months of the end of the accounting period.
FACT: If the company has no distributable reserves, it cannot pay dividends. So, if your company’s balance sheet starts a year with nil or negative reserves, then if you make no profit, you MUST STOP taking dividends as soon as you are aware of this. You should not take drawings that cannot be covered by non-existent dividends as essentially you are taking the company’s money out as a loan, AND THEREFORE YOU OWE IT BACK AS A DEBTOR.
The same situation occurs if you take a loan from the company to perhaps pay for something unexpected. Though you intend to pay it back, it rarely ever is!
A director can borrow from their own company provided that it is not in financial difficulty and follows the rules as set out in the Companies Act 2006 and the company’s articles of association. The shareholders must approve loans over £10,000, but less than £50,000, and the directors will need to agree to the loan terms such as the term and any interest charged. Taking loans from companies can complicate the tax affairs of the company and the director. It is much better to pay yourselves through PAYE and pay the tax and National Insurance Contributions.
If a company goes into a form of insolvency and the loan account is outstanding, (which for three quarters of insolvent companies a DLA is likely to be involved) the appointed liquidator will look to recover the debt for the benefit of the creditors, as of course, they will be acting with the creditors interests at heart.
In such circumstances options include:
The directors should try and pay back the loan! The liquidator will demand directors repay their debt to the company for the benefit of the creditors. Legal action can be taken to make directors pay this, which could even lead to personal bankruptcy. It is a liquidators duty to not let this be ignored and ensure the loan is repaid…it is not a way to avoid paying creditors.
When taking money from the company, it must be classed as a tax, being subject to a tax charge. This is because the company has lent money to you i.e. it is a benefit which is not a part of your salary. This is known as ‘Benefit in Kind’. HMRC see it as an interest-free loan as you are benefitting from it hence the reference, ‘beneficial loan’. However, this is not for all cases; if the loan is under £10,000, if the company charges the director interest and/or if the loan is used for certain purposes such as purchasing an interest in a partnership.
Moreover, if the overdrawn directors loan account exists in the nine months after the end of the company’s accounting period, a penal rate of tax known as Section 455 of S455 will be charged at a rate of 25%. Read more about S455 here.
S455 is charged, corporation tax or not, if your business has made a profit, seen a loss, or has already paid its tax…no exemptions. Only if the charge is paid on time (9 months after the company’s year-end) can you have the payment refundable (but as you can imagine, this is is a long-winded process!).
If you cannot repay the loan account nine months and a day after the company’s year end, HMRC charge interest on the loan which adds up until the S455 corporation tax or the director’s loan account is repaid. Only the corporation tax can be reclaimed at a later date, not the interest (at a rate of between 3-4%) paid.
In summary, the director will be taxed on the benefit received.
Mr Jones and Mr Smith set up a limited liability design and marketing company based in London.
Sales built quickly to £1.2m, based upon their contacts in the marketing sector. Their accountant told them the company had made £80,000 net profit in year one and this would be taxed for corporation tax purposes at roughly 20%.
The accountant advised them to leave their PAYE salaries at a lower level each month in year two and to take dividends from reserves and future profits. They did this for several years and paid themselves well as the company was profitable each year.
Then something happened. The company’s biggest debtor went bust owing the company c. £158,000. Silly to let that debtor take as much credit in our view, but their view was ‘after all, the company was a well known big name customer, and we never thought it would fail’. It had been good regular business for them, so we understand why it got to be such a big debtor.
The company’s failure led to a situation that was not planned for. In 2010, the company had a bad trading year on top of the customer’s insolvency, and so had to write the bad debt off. Therefore, the company made a significant loss for the year of £250,000. As a result, the balance sheet became negative, and they saw the first flashes of a cash flow crisis looming. No further dividends could be taken, and the directors now had overdrawn directors’ loan accounts to the tune of £50,000 in that accounting year that had to be paid back somehow.
Our advice in this situation would be to set out your objectives, look at the viability of the company and then make a decision to ACT.
Referring back to the case study, if the company entered formal terminal insolvency like administration, receivership, voluntary liquidation or compulsory liquidation, then the insolvency practitioner/liquidator could have demanded that the directors repay the £50,000 to the company for the benefit of creditors.
The critical test of any business in trouble is viability. One bad year and a substantial bad debt did not equate to a bad business – far from it. The company in the case study showed dedicated directors and staff.
In a case like this, we would recommend a CVA would be the best solution. The directors’ drawings for the current financial year were treated as being net pay through the PAYE scheme in that year because there were no distributable profits. Therefore dividends could not be paid. The prior year’s overdrawn directors’ account was repaid to the company in six months (a standard HMRC requirement) by the directors. This, of course, generates a slightly larger PAYE and NIC liability. But using the CVA, the debt would be bound by the process. Along with the reduction in employees and managers (the lost contract meant that they had too many people), the company was forecasting a modest profit at best or just below break-even at worst.
Creditors would benefit as they get a deal paying 55% of their old debt back over five years, and they kept their customer.
The benefits for the company are a downsized business, lower costs, long term survival, no lost contracts. We removed cashflow pressures while keeping the bank happy.
Directors would be able to avoid:
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What Does Going Into Administration Mean?
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What is Receivership?
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Appoint a receiver to administer and receive the company's assets.The receiver has a duty to collect the bank's debts only,they are not generally concerned with the other unsecured creditors or shareholders' exposure.Receivership - A typical appointment Having borrowed against a business plan that has not worked, a company finds that it is suffering cashflow problems. In an effort to survive, the company reports its problems to the bank and the bank asks for more information on the problems the company faces. Struggling with the problems of firefighting, the directors find it difficult to produce the information. Often the accountancy and reporting systems are not robust and a lot of time is needed to work out where the company is going, what the depth of the problems is and the necessary reporting to the bank is delayed.As time goes by, the company's overdraft is constantly at its limit, because monies don't come in fast enough from customers. Clearly this should set alarm bells ringing at the company - it most certainly does at the bank. They call this ceiling borrowing, and take it as a sign that the directors are losing control. When this happens the bank will review the account and will typically take some or all of the following steps: What the Bank will doThe bank will ask for a reduction in its exposure. It will ask for increased security from the directors or shareholders. Usually this takes the form of personal guarantees to support the security that the company has given through the debenture. It may ask for new capital to be introduced by the shareholders. Problem is though, occasionally, this only has the effect of reducing the bank exposure as the bank takes this cash to reduce the borrowing. It can ask for a new business plan from the directors, along with regular reporting. It may ask for the company to consider receivables finance (factoring) to remove its borrowing and move to a factor. Often the bank's own factoring company. If they are still not satisfied that the directors are in control and if the bank is concerned about its exposure it will ask for investigating accountants (or reporting accountants) to look at the business. Normally this is a large firm of accountants who send an insolvency practitioner (IP) into the business to ascertain:Is the business viable? Is the company stable? Does it have a long term future if the present difficulties can be overcome? Is the bank's exposure sufficiently covered in the event of a failure? In this report the IP calculates what the assets of the business are worth on a going-concern basis and in a forced sale scenario (or closure basis). Investigating accountants often recommend that the bank sticks with the business, but that the bank should limit any further borrowing to the fully secured variety - in other words the directors must secure it personally against property for example. If the IP thinks that the company is in serious risk of failure and that the banks may lose money in that event, he/she will usually recommend to the bank that they appoint a receiver or administrator. Usually the bank (bizarrely) requires the directors to "request the bank to appoint a receiver". This is face-saving, and designed to deflect criticism from the bank to the directors.At Company Rescue, we believe that it is wrong that the insolvency practitioner that carries out the investigation could also be the receiver - We think it is essential that his/her role as investigating accountant is limited to just that. However, fortunately most banks now agree that this is not a good approach. Once they are appointed what is the receiver's role and powers?A receiver will quickly ascertain what the prospects for business are and decide whether to sell some or all of the assets, the business as a whole, or to continue to trade whilst a better deal can be achieved. Because of the rules and case law, he may wish to get rid of the assets and staff as soon as possible. (They will have to adopt employment contracts 14 days after the appointment). They may remove directors and employees without impunity. They ultimately decides the way forward and will (often) not take advice from the directors. They must pay the preferential debts (employees claims for arrears of pay and holiday pay) first from any floating charge collections. If a deal is to be done with directors the receiver must first advertise the business and its assets for sale. They must conform to the tight rules and regulations governing receivership and report to the DBEIS. A receiver must investigate the conduct of the directors of the business and file a report with the DBEIS.Disadvantages of Receivership The company is rarely saved in its existing form. Its assets will be subject to "meltdown" ( most people know that in receivership or liquidation assets are sold at a knock down price), often jobs and economic activity are lost.The directors will typically lose their employment and any monies the company is due to them, and the company may cease to trade. In addition the director's conduct is investigated.From the creditors' perspective, it is unlikely that any unsecured creditors will receive any of their money back and often they lose a valuable customer. Clearly the cost of receivership can be very high and the bank has to underwrite the receiver's costs. Advantages of Receivership The bank can take control where directors have maybe lost control. The receiver also has power to act to save the business quickly. The bank can ensure that its exposure is (at least) not increased and hopefully recover all of its money. For directors, the advantages are that it mitigates the risk of wrongful trading and may crystallise a very difficult position allowing them to get on with their lives.Preferential creditors may see their debts repaid by the receiver.Still got questions? Click here for Receivership FAQs. If there are still unanswered questions contact us by email or call 08009700539.If your business is in trouble and the relationship with the bank is breaking down, we suggest that you look carefully at the guides in this site. Receivership may be an option. Work out the viability of the business - can you trim costs? Work out the problems, set out the position and have a meeting of directors. Decide if the business can continue but needs to be restructured or if just not viable then consider administration or if the company's lenders have a debenture pre-dating 2003 then receivership. These questions and answers will give more detailed background to the Administrative Receivership technique. If you have any further general or specific questions email us or complete the contact form. Q: How does it happen? A: Receivership can happen very quickly once the bank loses faith in the directors. The best policy is to work with the bank and produce a survival plan having taken professional and expert advice. Q: But the bank can't just appoint a receiver can they? A: Yes - read the terms of the debenture closely - you will be surprised how little power you have to prevent it. In truth the bank will generally have exhausted all possible avenues to help to try to preserve the business. If the directors are manifestly not up to the job or will not listen, will not take professional advice, they will lose patience quickly. Q: Can we stop them? A: Not normally. However if you talk to an experienced turnaround practitioner they can often persuade the bank that their involvement will lead to a review of viability followed by a professional recovery plan and the bank will usually give time for this to happen (within strict financial constraints) Q: How can we avoid receivership? A: Follow the guidance on this site. Discuss the problems with your key people. What caused them and how you can get round them. Build a plan for survival. Discuss this clearly with the bank. If in doubt about the correct route speak to a turnaround practitioner or a quality insolvency practitioner who lists rescue and recovery as a specialty. Be warned most are still looking for liquidations and receiverships (undertakers)If the bank wants to put investigating accountants in; wait until you have a built workable plan and then sell this HARD - to the investigating accountant.Above all demonstrate a professional and determined approach to saving a viable business - procrastinate at your peril - the bank will not wait for that silver lining. Q: I have heard that receivership is a rescue procedure - please explain? A: Many insolvency practitioners describe selling the business or its assets to a third party out of receivership as a rescue technique. Although some part of the activity may remain I cannot understand how the loss of almost all creditors' monies, jobs and all shareholders' funds, followed by the liquidation of the company, can be described as a rescue! Q: What happens if the receiver does not get the banks money back in full? A: He/she may rely upon the banks other securities. Obviously if the directors, shareholders or even a third party has signed a personal guarantee to pay money to the bank in the event of a failure to recover its loans, then the receiver pursues this as if it were an asset of the company. The receiver may also look at the possibility of legal actions against the officers of the company or debtors or creditors to recover funds Q: What happens to my personal guarantees in receivership? A: Unless the receiver recovers all loans due the bank after his/her fees (and any payments due to preferential creditors) then your PG will crystallise. In other words the receiver may seek to recover money from you. Q: What happens to the employees? A: This is a complex question that cannot be answered without a great deal of information. If the business is sold in a reasonable time then their employment rights can be continued with the new owners (under TUPE). If the receiver makes them redundant straight away they can claim for payments from the government (subject to a maximum amount). Again this is a complex question - email us if you want more detail.Please call us on 020 7887 2667 (London) or 08009700539 to talk to an expert turnaround advisor if you would like to talk through your company's options.
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