Overdrawn Directors’ Loans: What Recent HMRC Rulings Mean for You and Your Business
As a company director, you may have used your business’s funds to cover expenses or provide flexibility in your cash flow.
But when a director’s loan account (DLA) becomes overdrawn, what starts as a simple solution can quickly lead to serious tax, financial, and legal consequences.
Thanks to the current cost-of-living crisis, businesses are struggling more than ever - which means it’s also more important than ever to understand your obligations.
Here’s how McAlister & Co can support you if your director’s loan account becomes overdrawn.
What is a Director’s Loan Account?
A director’s loan account records transactions between you and your company other than salary, dividends, or reimbursed expenses. If you withdraw more than what the company owes you back - or take money before profits are available - it becomes an overdrawn DLA.
The Implications of Overdrawn Directors’ Loan Accounts
1. Section 455 Corporation Tax Charge
If your director’s loan remains outstanding more than nine months and one day after the company’s accounting period ends, the company is liable to pay Section 455 tax at 33.75% on the overdrawn balance (an increase from 32.5% from April 2022).This tax isn’t a penalty in itself - it’s a temporary charge meant to discourage long-term borrowing from the business.
Although this tax is repayable to the company nine months after the end of the accounting period in which the loan is repaid, that delay ties up vital cash. So, if you're already experiencing cash flow challenges, this tax can further strain your resources.
For example, if your company’s DLA shows a £30,000 overdrawn balance, the Section 455 liability would be £10,125. That’s money the business could otherwise use to stabilise trading, settle debts, or invest in recovery. This is exactly why proactive planning - such as structuring repayments, declaring dividends, or considering director salary adjustments - is key.
2. Benefit-in-Kind & National Insurance Reporting
Where a DLA exceeds £10,000 at any point during the tax year (without commercial interest charged), HMRC considers the loan a benefit-in-kind (BIK). This must be reported on a P11D form, and the company will incur a Class 1A National Insurance liability (currently 13.8%) on the value of the benefit.
Directors may also face an additional income tax charge on the loan as if it were interest-free credit - further complicating your personal tax situation. Charging interest on the loan at HMRC’s official rate (currently 3.75% for 2025–26) can reduce or eliminate the BIK, but this must be calculated and paid correctly to avoid penalties.
The BIK rules can catch directors unaware, especially if personal borrowing from the company is informal or undocumented. Without regular monitoring, you could end up facing unexpected tax bills - impacting both the company’s payroll and your own self-assessment return.
3. Personal Income Tax Risk If Loan Is Written Off
If the company decides to write off or forgive the loan, it is treated as income to the director - specifically as a dividend or salary equivalent - under Section 415 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). This means the director becomes liable for personal income tax on the written-off amount, potentially at higher or additional rates of tax.Moreover, HMRC insists that any write-off must be formally documented - including shareholder approval where necessary - otherwise it may be treated as an unauthorised or disguised distribution, carrying further tax implications.
It’s important to stress that “ignoring” the debt is not the same as writing it off. HMRC has successfully challenged cases where informal or implicit releases triggered income tax liabilities because no repayment action was taken.
4. HMRC Scrutiny & Compliance "Nudge Letters"
In recent years, HMRC has adopted a more proactive approach to monitoring DLAs. Directors with loan accounts exceeding £10,000 may now receive “nudge letters” reminding them of their tax reporting obligations.These letters typically urge directors to review past filings, confirm whether benefits-in-kind have been reported, and ensure any corporation tax due under Section 455 has been paid.
While not a formal investigation, these letters often serve as a preliminary warning. If issues aren’t addressed promptly, HMRC may launch a deeper enquiry - reviewing previous tax years and applying penalties for late or incorrect disclosures.
These letters are often triggered by inconsistencies in self-assessment returns, Companies House filings, or corporation tax computations - highlighting the importance of clear, consistent, and timely reporting.
5. Insolvency Consequences & Director Liability
If your business becomes insolvent and a formal insolvency process begins (such as liquidation or administration), any overdrawn DLA becomes an asset of the company. Insolvency practitioners have a legal duty to recover those funds - regardless of whether the business was struggling or the loan was longstanding.This can result in personal liability for the director, particularly if the loan is substantial or if the withdrawals worsened the company’s financial position. In some cases, practitioners may seek legal action to enforce repayment. If repayment is not possible, this could lead to:
- Personal bankruptcy
- Disqualification from acting as a company director (under the Company Directors Disqualification Act 1986)
- Potential claims for misfeasance, particularly if the withdrawals breached the director’s fiduciary duties
Furthermore, in pre-insolvency reviews, HMRC and liquidators often treat DLAs as red flags. If the company failed to meet tax obligations while directors drew funds, questions about unfair preference or wrongful trading may arise.
Recent HMRC Rulings: What You Need to Know
- FTT — Quillan v HMRC
The First‑Tier Tribunal clarified that unless a loan is formally released or written off, the Section 415 income tax charge doesn’t apply - even if it's unlikely to be pursued. This reinforces the importance of formal procedures in loan write-offs.
- Novation & Deeming Ruling
In a separate case, a loan novation was treated as a release, triggering an income tax charge under Section 415, because it effectively discharged the director's debt. Directors must understand that even complex transactions can carry unexpected tax implications.
Why This Matters for Your Business and You
1. Unexpected Tax Bills
An overdrawn DLA isn’t just an accounting line—it can mean a sudden corporation tax bill of up to 33.75%, plus personal tax liabilities and NI charges.
2. Cashflow Strains
Reclaiming the corporation tax only after the loan is repaid means cash flow pressures can persist, especially in struggling companies.3. Regulatory Risk
HMRC’s proactive communications signal that previously overlooked accounts are now under targeted compliance scrutiny.4. Liability on Business Failure
In an insolvency scenario, an overdrawn DLA could be among the first things liquidators look to recover, exposing directors to serious financial liability.What You Should Do Now
Review Your DLA Regularly - Monitor your balance monthly, not just at year-end, to avoid unexpected tax obligations.
Aim to Clear or Plan the Tax - Repay overdrawn amounts before the nine-month deadline, or set aside enough to cover the Section 455 charge.
Manage Borrowings Carefully - For repeated withdrawals, declare them formally as salary or dividends. Issue interest at HMRC’s official rate (3.75% for 2025–26) to justify the arrangement.
Document Formal Write-Offs or Releases - If writing off a loan, follow formal minutes, shareholder resolutions, and documentation to avoid triggering income tax under Section 415.
Respond to HMRC’s Nudge Letters - Don’t ignore them - use nudge letters as a prompt to get your DLA records and tax filings in order.
Seek Specialist Advice Early - As with all financial difficulty, the sooner you seek advice, the better. Complex cases - such as novation, insolvency, or write-offs - need expert guidance to avoid mistakes that could cost tens or hundreds of thousands.
How McAlister & Co Can Help
At McAlister & Co, we specialise in guiding directors through the complexities of overdrawn DLAs:
- DLA Audits & Planning
We review your director’s loan account, propose strategies to settle balances tax-efficiently, and advise on interest, dividends, or repayments.
- Tax & Reporting Guidance
We'll ensure your company handles Section 455 charges, P11D filings, and Section 415 considerations correctly.
- Formal Write-Off Support
We prepare the necessary documentation and resolutions to formally release a loan, protecting you from future income tax claims.
- Insolvency Navigation
If your company is struggling financially, we can help you assess your situation, liaise with insolvency practitioners, and plan repayments - or negotiate a CVA to protect your personal and business interests.
- Dispute & Negotiation Assistance
In the event of HMRC enquiries or liquidator demands, our team supports you throughout resolution and negotiation.
Need Help with an Overdrawn Director’s Loan?
An overdrawn director’s loan may offer convenience in the short term - but with significant risks. The safest approach is to stay ahead, and make sure you monitor, manage, and formally document your DLA.
If complications arise, or if you're feeling overwhelmed, reach out to McAlister & Co. We'll work with you to craft solutions tailored to your circumstances - protecting your business and safeguarding your future.
Need help with an overdrawn director’s loan? Contact McAlister & Co today for expert guidance.