By Connor Smith, Accountant at Hive Business

Operating in the corporate environment has some significant differences to operating as a sole trader and owning a company comes with a number of formalities. One of the biggest differences you’ll find when switching to a limited company is how “drawings” are treated.

We’ve written previously about a director’s responsibilities but one of the crucial aspects of a company is the director’s loan account.

In simple terms, unless formalised as a salary through the payroll, or evidenced by dividend minutes, all drawings taken from a company by its director are de facto classed as loans.

A director’s loan account becomes overdrawn when the money drawn from the company exceeds the money that a director has introduced over the course of their directorship. Having an overdrawn loan account at the company’s year-end has potential tax implications. Broadly speaking, unless this issue is addressed, the company will be hit with a tax penalty, payable together with the usual corporation tax nine months after the year end. This tax penalty is charged on the total amount of any overdrawn loan accounts, and is the same rate as a dividend taken at the higher rate of tax (32.5%).

So, for example, if a director has withdrawn £10,000 more than funds introduced, the company will be liable to a tax charge of £3,250.

The only way to avoid the tax penalty after the year end has already passed is for the director to reintroduce the overdrawn funds to the company within nine months of the company year-end. If, however, this is not possible, the tax penalty will be due. This will be held on account by HMRC until such a point that the loan is repaid, upon which an application to reclaim this tax penalty amount can be made. It’s also worth bearing in mind HMRC hold onto it for a period of time post-reclaim.

Clearly then, trying to resolve an overdrawn loan account after the year end is a considerably arduous task with limited options. It is therefore vital that, as a responsible director of a company, you are monitoring your drawings from the company in real time and taking the appropriate measures to avoid an overdrawn loan account. Such proactive measures include:

• Appropriately documenting dividends in real time, with vouchers and signed minutes;
• Reviewing all direct debits paid via the company, to ensure things such as personal pension payments and insurances are made from a private bank account, and;
• Keeping your bookkeeping accurate and up to date, to identify if drawings from the company are becoming an issue in advance of the year end.

Often we find overdrawn director’s loan accounts are a tell-tale symptom of deeper financial and organisational problems at a business, so if this is a problem you have experienced in the past, get in touch with us to see how we can help get your finances back on track.