Overdrawn Directors Loan Account: What It Means, Why It Happens, and How to Fix It

Many UK directors don’t realise they’ve run up a tax problem until their accountant or HMRC flags it. A director’s loan account (DLA) on its own isn’t an issue, but when a company director borrows money beyond what they’re entitled to, the account becomes overdrawn and can trigger significant tax and legal consequences. If not addressed promptly, directors may face unexpected income tax bills, additional reporting requirements, and even personal financial liability.

The subject often feels more complicated than it needs to be. But once you understand how DLAs work, why problems arise, and what HMRC expects, the solutions become much clearer. This article sets out the essentials: what an overdrawn director’s loan account actually is, why directors end up in this position, what the risks are if nothing is done, and the practical steps to put things right. We’ll also look at the wider legal framework and give examples that show just how seriously HMRC and liquidators treat these balances. the practical tips you can take to adapt. From intent-focused content to preparing for AI-powered search, you will find clear, actionable guidance to strengthen your blog writing strategy and ensure every new blog post resonates with readers.

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What is an Overdrawn Directors Loan Account?

A director’s loan account records the flow of money between a company director and their business. It keeps track of company funds taken out of the business that aren’t classed as:

• Salary (processed through PAYE)

• Dividends (legally declared from profits)

• Legitimate business expenses (reimbursed)

If the director withdraws more than they have put in or more than they are entitled to, the account becomes “overdrawn.” At this stage, the balance is effectively a loan from the company to the director.

While some directors assume this is harmless, HMRC views it differently. Overdrawn DLAs affect both the company’s Corporation Tax position and the director’s personal tax liability. Importantly, under the Companies Act 2006, loans over £10,000 usually require shareholder approval via ordinary resolution. In owner-managed businesses, this may feel like a formality, but it is still a legal requirement.

Why Directors End Up Overdrawn

Directors rarely set out to borrow from their company, but a mix of cashflow pressures and poor planning means it happens more often than you’d think. Here are some common causes:

1. Deferring Personal Tax

Some directors take drawings throughout the year with the idea of declaring dividends later. If profits fall short or reserves are negative, those drawings remain as a loan instead of being cleared against dividends. This can leave an overdrawn balance sitting on the company’s books.

2. No Clear Remuneration Policy

A structured approach to pay; combining salary and dividends, reduces risk. Without it, directors often dip into the company account whenever needed, withdrawing money informally. Over time, balances drift into the red without anyone noticing.

3. Incorrect Coding in the Accounts

It’s easy for personal spending; meals, subscriptions, or family travel, to end up booked through the company. Unless these are cleared and reimbursed, they add to the DLA.

4. Window Dressing the Accounts

Some directors avoid processing dividends or salary to increase reported profits. While this might make the numbers look better in the short term, it leaves unexplained balances sitting in the loan account, distorting the company’s financial position.

5. Lack of Awareness

The simplest reason of all: directors just don’t realise. Without regular bookkeeping, a clear picture of the DLA isn’t available until year-end, at which point it’s often too late to correct things without a potential tax charge.

What Happens If It’s Not Repaid?

Leaving an overdrawn loan account unresolved has serious consequences. Here are the main ones:

A. Section 455 Corporation Tax

If the loan isn’t repaid within nine months of the company’s year-end, the company must pay Section 455 tax:

• 33.75% of the outstanding amount

• Payable alongside Corporation Tax

• Reclaimable only once the loan is genuinely repaid

This acts like a penalty. Even though it can eventually be reclaimed, the cashflow hit can last for months or years.

B. Benefit-in-Kind (BIK) Tax

If the loan exceeds £10,000 and the company charges no interest, HMRC treats it as a “cheap loan.” The consequences are:

• The director pays personal tax on the deemed interest benefit

• The company reports the loan on a P11D

• The company pays Class 1A National Insurance contributions

Example (2025/26): A £15,000 loan outstanding for a full year with no interest creates a benefit of £562.50 (calculated at HMRC’s official rate of 3.75%). The director pays tax on this at their marginal rate, and the company pays Class 1A NI at 15%.

C. Insolvency Risk

In insolvency, the DLA becomes a company asset. Liquidators are legally obliged to pursue repayment. Research suggests 75–80% of UK business insolvency cases involve overdrawn DLAs. If dividends were paid unlawfully, these too can be reclaimed. Attempts to write off or disguise the loan often fail, and directors risk disqualification for up to 15 years in cases of wrongful trading. When the company enters insolvency, the loan is treated as a debt owed, and repayment may be enforced by company’s creditors through legal action.

How to Fix an Overdrawn DLA

Fortunately, there are several ways to resolve the problem, though each comes with different consequences.

1. Repay the Loan

This is the cleanest option. It clears the balance, avoids Section 455 tax, and removes benefit-in-kind exposure. But be careful:

• The repayment must be real money, not just a journal entry

• Avoid redrawing more than £5,000 within 30 days, or HMRC may treat it as avoidance

• HMRC’s “arrangements rule” also applies if the loan amount exceeds £15,000 and there was intent to re-borrow £5,000 or more, even if that redrawing happens months later

2. Declare the Balance as Salary

The loan can be reclassified as employment income. This is subject to PAYE and National Insurance but gives a clean outcome. It may be attractive if the director has unused personal allowance or if payroll is already in place.

3. Declare as a Dividend

If the company has sufficient distributable reserves, the loan can be offset against dividends. This avoids NIC but is taxed personally. Crucially, it is illegal for limited companies to pay dividends if the entity is in negative equity.

4. Accept the Tax Consequences

If repayment or reclassification isn’t viable, the company pays Section 455 tax and the director pays personal tax on the benefit-in-kind. This is generally a last resort and rarely the most efficient choice.

Planning for the Future

Avoiding problems with directors’ loans is about forward planning, discipline, and awareness of the legal framework. Some practical steps include:

• Pay Yourself Properly: Put a remuneration plan in place that balances PAYE salary with dividends, based on available profits.

• Separate Finances: Never use the company account as a personal wallet. Keep business and personal finances separate.

• Monitor the DLA Regularly: Check the account monthly, and schedule quarterly reviews with your accountant. Early intervention makes problems with outstanding loans easier to fix.

• Understand Legal Restrictions: Loans above £10,000 need shareholder approval.

• Stay Alert to HMRC Enforcement: HMRC actively monitors DLAs and frequently writes to directors to check compliance. Penalties and even criminal liability can follow in cases of serious breaches, so always seek professional advice if in doubt.

Final Thoughts

An overdrawn director’s loan account can look like a small technicality but can quickly snowball into a serious tax and legal problem. The combination of Section 455 charges, benefit-in-kind rules, and insolvency risks means directors should treat the issue with urgency. If left unmanaged, what starts as a small balance can develop into real financial difficulty, particularly if the company’s position deteriorates.

The good news is that DLAs can be managed and resolved. Whether through repayment, reclassification as salary or dividend, or a structured long-term plan, directors have options. The key is transparency, discipline, and proactive advice. By keeping accurate records, understanding the Companies Act requirements, and working with a trusted accountant, directors can prevent the problem from arising again.

Ultimately, the best approach is prevention. A clear remuneration strategy, proper bookkeeping, and awareness of HMRC’s rules mean directors can stay compliant and avoid the stress of unexpected tax bills or legal demands. With the right systems in place, a DLA doesn’t need to be a source of risk; it can simply be another part of running a business responsibly.

About Ysobelle Edwards

Ysobelle Edwards provides financial management consultancy and bookkeeping services to small businesses across the UK. We help business owners stay compliant, understand their numbers, and plan with confidence.

If you’d like clarity on your director’s loan account or support with wider financial management, get in touch to see how we can help.

Frequently Asked Questions

• What happens if your director's loan account is overdrawn?

  An overdrawn director’s loan account means the director owes money to the company. If it isn’t repaid, HMRC charges Section 455 tax at 33.75% and may apply a benefit-in-kind charge if the loan is over £10,000.

• What is the 9 month rule for directors loan?

  The 9-month rule requires directors to repay loans within nine months and one day of the company’s accounting period year-end. If not repaid, Section 455 tax at 33.75% is charged on the outstanding balance.

• What happens if you can't pay back a director's loan?

  If you can’t repay a director’s loan, the company pays Section 455 tax, and the director may pay benefit-in-kind tax. In insolvency, the liquidator can recover the loan personally from the director.

• How do you write off a directors loan account debit balance?

  A director’s loan can only be written off as salary, allowable expenses or dividends. Both options are taxable. Writing off the balance without this treatment is not allowed and risks HMRC penalties.

• Is a director’s loan a legal requirement to report?

  Yes. Overdrawn director’s loans must be reported in the company’s accounts. Loans over £10,000 with no interest must also be reported on the director’s tax return as a benefit-in-kind. This reflects the principle that the company is a separate legal entity, and transparency is required.

• Do directors pay interest on loans from their company?

  Yes. If the loan is over £10,000 and no interest is charged, HMRC applies a deemed interest charged rate of 3.75% (2025/26), which is taxed as a benefit-in-kind.

• Can a director’s loan be written off in insolvency?

  No. In insolvency, overdrawn director’s loans are assets of the company. The liquidator must recover the money from the director, and the balance cannot be written off.

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