So you have an overdrawn directors loan. You didn’t even know what it was at first, but you really need to know why it’s a problem.
Basically, the problem is that it looks like you owe your business money and that might lead to some, possibly significant, tax to pay.
How did this happen?
Maybe you didn’t quite have your planning right or maybe circumstances changed during the year.
So for example, you may be taking £4,000 a month as dividends but then at year-end there isn’t enough profit for you to have done that. So all of a sudden you’ve taken £48,000 but your business only has profits to support £40,000 over the course of the year.
So you owe your business £8,000
Why is this a problem?
The short version is: it gets taxed at a higher rate. Much higher. You don’t want this tax rate.
If that £8,000 isn’t down as salary or dividends, it’s now down as your income and therefore it looks like you’re receiving £8,000 without paying any tax. As you can probably guess, HMRC don’t like that! So they tax the company to get their money.
BUT – if the loan is eventually repaid the tax is also repaid. That means for some just leaving it can actually be ‘ok’.
How do I fix it?
Three things you can do:
Repay the money.
Maybe you took some money to cover a personal short term cost and want to pay back the money. Simply transfer the balance back to the business bank account and the loan will be cleared.
Take extra dividends to clear it.
It may be you’ve not taken all you can from the business yet and can take an additional dividend.
However, you won’t receive any cash as this has effectively already been received (that’s why we have this overdrawn loan in the first place).
A more accurate depiction might be to say your reclassifying the money taken as a dividend.
Write it off.
If you can’t repay or take a dividend and you don’t think you would be able to do either of those things in the future, you may need/want to write the loan off.
The individual would see this write off as a dividend on their personal tax return and be taxed accordingly. For the company, the write-off would further increase the losses and therefore mean it would take even longer to return to accumulated profits and the ability to take dividends in the future.
This route is not one to be taken lightly and should always come after advice from your accountant.
Be careful of deadlines
To avoid any tax, ideally this overdrawn loan should be cleared before the end of the accounting year. If it isn’t, you have a further 9 months to clear it, otherwise the tax becomes payable.
Need advice about an overdrawn director’s loan? Contact us here.