An overdrawn director’s loan account is one of the most common, and most underestimated, tax risks faced by UK company directors.
It rarely starts as a deliberate tax strategy. More often, it begins with small withdrawals: paying a personal bill from the company account, taking money out between dividend declarations, or using company funds temporarily with the intention of “sorting it out later”. Over time, those small withdrawals can quietly build into a significant overdrawn balance.
When that happens, the consequences can be serious. An overdrawn director’s loan account can trigger Section 455 tax charges, benefit-in-kind liabilities, cashflow pressure, and in extreme cases, personal legal exposure if the company later faces insolvency.
This guide explains, in clear and practical terms, how overdrawn director loan accounts work, what Section 455 really means, the tax and legal risks directors face, and how to manage or fix the situation properly, without unnecessary jargon or scare tactics.
What Is a Director’s Loan Account?
A director’s loan account (DLA) is a running record in the company’s books that tracks all financial transactions between a director and the company that are not:
- Salary processed through PAYE
- Dividends formally declared
- Reimbursed business expenses
The director’s loan account captures movements such as:
- Money the director lends to the company
- Money the director borrows from the company
- Personal expenses paid by the company
- Timing differences between drawings and formal remuneration
A director’s loan account can be:
- In credit – the company owes the director money
- Overdrawn – the director owes the company money
What Does an Overdrawn Director’s Loan Account Mean?
A director’s loan account becomes overdrawn when the director has taken more money out of the company than they have put in, outside of salary or properly declared dividends.
Common causes include:
- Paying personal expenses directly from the company bank account
- Withdrawing funds before dividends are declared
- Taking “temporary” loans and not repaying them promptly
- Drawing dividends when the company does not yet have sufficient profits
An overdrawn director’s loan account is not illegal in itself. However, once it exists, specific tax rules apply, and ignoring those rules can lead to unexpected tax bills and compliance issues.
Why HMRC Closely Monitors Director Loan Accounts
HMRC pays close attention to director loan accounts because they can be used, intentionally or unintentionally, to extract value from a company without paying the correct tax at the correct time.
From HMRC’s perspective, an overdrawn director’s loan account may represent:
- Disguised income
- An interest-free personal loan
- Deferred personal taxation
- A risk to company creditors
This is why strict tax legislation exists, particularly Section 455 of the Corporation Tax Act, which is designed to discourage directors from leaving loans outstanding for long periods.
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Section 455 Tax Explained
What Is Section 455?
Section 455 tax is an additional corporation tax charge that applies when:
- A director (or shareholder) owes money to the company, and
- The loan is not repaid within 9 months and 1 day after the end of the company’s accounting period
The tax is paid by the company, not the director personally.
What Is the Current Section 455 Tax Rate?
- 33.75% of the outstanding loan balance
- Calculated on the amount owed at the deadline
- Declared on CT600A alongside the corporation tax return
Example of a Section 455 Charge
If a director owes the company £50,000 at the year end and does not repay it within the required timeframe:
- Section 455 tax due = £16,875
- Payable even if the company has made a loss
- Paid in addition to normal corporation tax
This often comes as a shock to directors because the tax can be substantial and does not depend on profitability.
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Why Section 455 Is a Cashflow Problem, Not Just a Tax Issue
Although Section 455 tax is technically refundable, the timing is critical.
How the Refund Works
- The loan must be fully repaid
- The company can only reclaim the tax after the end of the accounting period in which repayment occurs
- The claim is made through CT600A
- HMRC processing times can be lengthy
In practice, this means:
- Cash can be tied up for months or even years
- Growing companies may struggle with working capital
- Borrowing or delayed investment may become necessary
This is why proactive planning is far more important than simply knowing the tax rate.
Anti-Avoidance: What HMRC Watches For
HMRC will scrutinise situations where:
- A loan is repaid just before the deadline, and
- The director withdraws similar funds shortly afterwards
This practice, often called “bed and breakfasting”, may be challenged if HMRC believes the repayment was not genuine.
To be effective, repayments should:
- Be commercially real
- Not be immediately reversed
- Be supported by proper records
Other Tax Implications of an Overdrawn Director Loan Account
Section 455 is only part of the picture. Overdrawn DLAs often trigger additional tax consequences.
Benefit-in-Kind on Director Loans
If a director’s loan exceeds £10,000 at any point during the tax year and is:
- Interest-free, or
- Charged at below HMRC’s official rate
The loan may be treated as a beneficial loan.
This creates:
- A benefit-in-kind for the director
- Income tax payable by the director
- Class 1A National Insurance payable by the company
- Reporting via P11D
Charging Interest Instead
As an alternative, the company may:
- Charge interest at HMRC’s official rate (or a commercial rate)
- Treat interest received as taxable income
Interest charged:
- Is subject to corporation tax in the company
- Avoids benefit-in-kind reporting if charged correctly
Choosing between interest vs benefit-in-kind treatment requires careful comparison, as the most tax-efficient option depends on:
- The director’s income tax band
- The company’s corporation tax rate
- Whether P11Ds are already prepared
- The size and duration of the loan
Can You Offset an Overdrawn Director Loan Against Dividends?
Yes, but this is one of the most misunderstood and risky areas.
When Dividend Offset Is Allowed
You can offset an overdrawn director loan against dividends only if:
- The company has sufficient distributable reserves
- Dividends are properly declared
- Board minutes and dividend vouchers exist
- The dividend is credited to the DLA
Illegal Dividends: A Common and Costly Mistake
Dividends become illegal when:
- They are declared without sufficient profits
- They are backdated
- They are assumed rather than formally approved
Illegal dividends:
- Must legally be repaid
- Do not clear Section 455 exposure
- Can create personal liability in insolvency
This is one of the most common reasons HMRC and insolvency practitioners challenge director loan accounts.
Not sure whether dividends, salary, or repayment is the right route?
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What If the Loan Cannot Be Repaid?
If a director cannot repay an overdrawn loan, several outcomes may arise:
1. Loan Written Off
- Treated as income for the director
- Subject to income tax
- May trigger National Insurance
- Often the least tax-efficient option
2. Treated as Salary or Bonus
- Subject to PAYE and NIC
- Clears the loan
- Usually expensive from a tax perspective
3. Left Outstanding
- Section 455 tax applies
- Interest or benefit-in-kind may arise
- Risk increases over time
Overdrawn Director Loan Accounts and Insolvency
This is where the personal risk becomes real.
If a company enters liquidation:
- The overdrawn director loan account is treated as a company asset
- Liquidators have a legal duty to pursue repayment
- Previous write-offs may be ignored
In practice:
- Repayment demands are common
- Legal action may follow
- Directors may face personal financial pressure
Industry data consistently shows that overdrawn director loan accounts appear in the majority of insolvency cases, often catching directors by surprise.
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Legal and Compliance Risks for Directors
Beyond tax, overdrawn DLAs can create:
- Breach of fiduciary duties
- Allegations of misfeasance
- Director disqualification risk
- Increased scrutiny during audits, funding, or sale
Poor record-keeping significantly increases these risks.
How to Record an Overdrawn Director Loan Account Correctly
From an accounting perspective:
Balance Sheet Treatment
- Shown as a current asset
- Disclosed separately if material
- Supported by clear transaction records
Common Errors
- Posting drawings as expenses
- Misclassifying dividends
- Mixing personal and company spending
- Ignoring timing differences
Accurate records are critical for:
- HMRC compliance
- Due diligence
- Insolvency protection
Best Accounting Software for Managing Director Loan Accounts
Good accounting software can help, but only if used correctly.
Effective systems allow:
- Real-time DLA tracking
- Clear audit trails
- Accurate dividend posting
- Regular review of balances
However, software cannot replace:
- Proper setup
- Monthly review
- Professional judgement
Many overdrawn DLAs exist simply because no one is actively monitoring them.
How to Correct Errors in an Overdrawn Director Loan Account
Errors are common and often fixable if addressed early.
Corrections may involve:
- Reclassifying personal expenses
- Declaring valid dividends (where profits exist)
- Adjusting remuneration
- Correcting bookkeeping entries
Corrections should always be:
- Fully documented
- Legally defensible
- Reviewed before accounts are finalised
FAQs related to Overdrawn Director Loan Account
Section 455 tax, benefit-in-kind charges, interest implications, penalties, and possible personal tax exposure.
Final Thoughts
Overdrawn director loan accounts rarely cause immediate problems, but when they do, the impact can be significant.
Handled properly, a director’s loan account can be a flexible and legitimate financial tool. Handled casually, it can result in unexpected tax bills, cashflow strain, and personal exposure at the worst possible time.
Early review and structured planning are almost always cheaper than fixing problems later.
A Practical Next Step
If your director’s loan account has ever gone overdrawn, even briefly, a professional review can:
- Identify Section 455 exposure
- Confirm dividend legality
- Correct historic errors
- Reduce future risk
If your director’s loan account has ever gone overdrawn, even briefly, a short review can help you avoid unnecessary tax and personal risk.
Our initial consultation is free and designed to give clarity, not pressure.
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Disclaimer: This article provides general guidance only. Every company’s circumstances are different, and tailored professional advice should always be sought.
