Some people see directors loans as a perk of running a company but the reality is that they come with a sting in the tail – and that sting just became more painful.
For some time It has been the case that where Directors have overdrawn loan accounts in a company, that company would face an additional 25% corporation tax charge on the loan balance, if that loan remained outstanding nine months after the company’s year end.
Following the introduction of the Finance Bill 2016, legislation has been introduced to link the rate of tax chargeable on these loans to the higher dividend rate meaning an increase from 25% to 32.5 % from 6th of April 2016 onwards. This has clearly been implemented to discourage the use of company loans by Directors.
For any Director with an overdrawn loan account, we would recommend that they do all they can to ensure that the loan will be eliminated before the end of the 9 month period. From an insolvency perspective, once a company enters into a formal mode of insolvency, the insolvency office holder has a duty to recover all outstanding debts due to the company and this will include any overdrawn loan account balances in respect of the Directors. It would be wise therefore for all Directors, even those of the most solvent companies, to plan for the unthinkable and in doing so, ensure that they will never be in a position where they have an overdrawn company loan to account for beyond their means of repaying.
Quite often, in small, owner-managed businesses, overdrawn loan accounts arise where Directors remunerate themselves by taking loans from the company which are repaid at a later date from the proceeds of dividends. Common scenarios that we see involving small companies where the directors are also shareholders, are where loans have been drawn on a monthly basis but by the end of the year the profits generated are less than sufficient to cover them, meaning that the shortfall remains posted against the directors loan account; or where a company goes into Liquidation before the dividends had been declared.
In both of these scenarios an insolvency office-holder has an obligation to pursue the Director for repayment of the overdrawn loan account.
This can be avoided by Directors preparing monthly management accounts and declaring dividends on a monthly basis. This would also act as a safeguard against a Director receiving dividends beyond the level of retained profits available. By implementing these measures a Director can be certain that they are reducing the possibility of an Insolvency Practitioner pursuing them for an overdrawn directors loan account should their company face a formal insolvency in the future.