Risks of Operating a Director Loan Account

Risks of Operating a Director Loan Account

Risks of operating a Director Loan Account

Should a director of a privately owned limited company restrict his/her salary and not pay it all through the company PAYE scheme?

For many years directors have used their director loan account to draw money from their company in lieu of salary– why?

Tax efficiency – Drawing funds below the National Insurance (NI) threshold through the PAYE scheme might be considered a tax-efficient way to minimise the amount of NI contributions and income tax payable by the director for a period of time.  This could result in lower overall tax liabilities compared to taking all income as traditional ‘wages’.

Dividend taxation – By allocating declared dividends at a much later date to clear a Director Loan account instead of a bonus through the PAYE scheme – however changes to dividend tax treatment in recent years has made this less attractive.

Avoiding excessive salary costs – If the company’s profits are not sufficient to support a higher salary for a director – taking additional sums in the form of a director’s loan could be considered by some that it helps the company manage cash flow better, avoiding the higher salary being immediately payable through the monthly PAYE scheme.

Flexibility – Using a director loan account can allow more flexibility in how the funds are distributed and repaid to the director.  It can be a way to navigate through periods of varying cash flow in the business.

Retaining profits in the company – By not drawing full salary levels, this shows higher company profits and the business can appear to be in a stronger trading position.

Repayment of funds previously invested by the director/shareholder into the company – A director may have made significant personal investment in the company, particularly in the early stages of set up as a loan advance to the company.  Taking repayment of these funds instead of salary means no tax is payable by the director on the sums repaid.

It is crucial for directors to consult with a qualified accountant to determine the most suitable and legal approach for drawing funds from their company.  The taxation rules and implications can be complex and differ depending on the circumstances of the company and director.  Tax laws and regulations may change over time as well as the company performance.  It is essential to stay up to date with the latest information and understand the implications and ramifications of how funds are paid to the director.

What are the possible pitfalls and risks involved in drawing funds via a director loan account?

Insufficient funds remaining in the director loan account resulting in it being “overdrawn”.

An overdrawn director loan account means it is an asset of the company and is repayable to the company.

Tax implications – An overdrawn director loan account is a benefit in kind with national insurance being payable on interest not paid.  It can also result in additional company tax being payable by the company until such time as the director loan account is repaid.

Dividends – Declaring dividends can be a method used to clear an overdrawn director loan account.  These must be declared on the director tax return and the company reserves reduced by the value of dividends drawn which in turn reduces the company balance sheet net worth.   The company must hold sufficient reserves/net worth/retained profits to justify the declaring of the dividend otherwise it is deemed “illegally” drawn and is repayable to the company.

Company placed into liquidation – Where a liquidator is appointed – either a voluntary liquidation initiated by the shareholders or a compulsory liquidation by the court – the liquidator will:

  • Identify any director loan accounts – conducting a thorough investigation and examination of the company’s financial records to identify any outstanding director loan accounts.
  • Gather evidence – to substantiate that the funds were indeed taken by the directors (or paid to connected parties) and should be recorded as director loans.
  • Demand for repayment – once the director loans are identified the liquidator will issue a formal demand to the directors for repayment of all outstanding amounts – typically including a specific timeframe for repayment.
  • Negotiation and settlement – if the directors dispute the amounts owned, this will require validation and there may be negotiations between the liquidator and the directors to agree a settlement.
  • Legal action – if the directors refuse to cooperate or fail to repay the outstanding amounts within the specified timeframe, the liquidator can take action to recover the funds. This could involve court proceedings and ultimately lead to a threat of bankruptcy impacting the director’s personal assets.
  • Voidable transactions – the liquidator may also investigate whether any transactions involving the director loan accounts or within the company records could be considered “voidable” under insolvency law. Any transactions of a personal nature applied through the company accounts will be allocated to the director loan account and repayable to the company.
  • Reporting to the authorities – in some cases the liquidator may report any misconduct or fraudulent activities to the relevant authorities or regulatory bodies.


It is important to understand fully the ramifications of operating a director loan account or using the company accounts for personal means.  Monthly management information that accurately records the company profits and reserves is essential to show these are sufficient.  Where reserves are depleted and the company incurs trading losses, any overdrawn director account balances and personal withdrawals need to be repaid.


Without accurate management information, directors may be unaware of the extent to which a director loan account is overdrawn and may not take action quickly enough, resulting in considerable sums requiring to be repaid to the company personally by the director.  Directors are often not fully aware of the extent of their director loan account or that it is fully repayable to the company on demand.


Directors should operate director loan accounts with caution and ensure they are fully aware of the balance due.   Where a company’s trading performance and reserves decline, consideration should be given to stop using the director loan account and whether or not the company is able to trade out of difficulties.  Continuing to withdraw sums from a company month on month may lead to considerable personal financial hardship later. Waiting until the company year-end accounts are prepared may be too late.


Our team at Dunedin Advisory has a wealth of experience advising directors and their advisors of their options and practical solutions to take forward.  Whilst many directors operate director loan accounts successfully, some are unaware of the risks if the company were to face difficulties.     Contact us on 01592 630085 for an initial free meeting to discuss your options. www.dunedinadvisory.com

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