Can You Close a Company with a Director’s Loan?

Closing a company can be a complex process, especially when there are outstanding debts, including a director’s loan. Running a small business sometimes doesn’t go to plan and debts can build up. If you can’t repay those debts, you could end up in a situation where ultimately you need to close the company.

Decisions will need to be made and the correct steps followed in sequence to do this as efficiently as possible. But what happens if one of those outstanding debts is money owed to the company as a director’s loan? This article aims to shed light on the possibility of closing a company with a director’s loan, the consequences of an overdrawn loan, and potential ways to address this situation.

So, if you have been left confused as a business owner about the nuances around ‘can I close a company with a director’s loan?’ here’s the simple answer: 

Yes, it is possible to close a company with a director’s loan. However, there are specific steps that need to be considered when closing a company with an outstanding director’s loan. The process may vary depending on the company’s legal structure (e.g., limited company) and the amount of the loan.

So, the short answer is yes you can close a company with a director’s loan account but with most big decisions in life there are many important considerations. We have covered various scenarios below to help you understand when and how you can liquidate your company if you have a director’s loan account.

How do you close a company with an outstanding director’s loan?

Here are some important considerations to take before closing a company with an outstanding director’s loan. 

Loan Repayment: Before closing the company, the director’s loan should ideally be repaid in full. If the director’s loan cannot be repaid immediately, there should be a clear plan in place for repaying the loan after the company is closed.

Alternative Arrangements: If it is not possible to repay the loan immediately, the director and the company may consider alternative arrangements for the loan, such as converting it into a different form of finance or agreeing on a repayment plan that extends beyond the company’s closure.

Company Assets and Liabilities: Before closing the company, all its assets and liabilities, including the director’s loan, must be accounted for, and properly dealt with. The director’s loan is considered a liability of the company, and it should be included in the final financial statements.

Insolvency Considerations: If the company is insolvent (i.e., it cannot pay its debts as they fall due), there are specific insolvency procedures that must be followed, and the treatment of the director’s loan can be more complex. In such cases, seeking advice from an insolvency practitioner or a qualified professional is essential.

HMRC Notification: When closing a company, you must notify HM Revenue and Customs (HMRC) of the company’s closure and settle any outstanding tax liabilities, including any tax implications related to the director’s loan.

Legal Obligations: The closure of a company involves specific legal obligations, such as filing the appropriate documents with the relevant authorities (e.g., Companies House in the UK). It’s crucial to ensure all legal requirements are met during the closure process.

Final Accounts: Final accounts and tax returns should be prepared and submitted to the appropriate authorities before closing the company.

Closing a company can be a complex process, especially when there are outstanding director’s loans or potential tax implications. 

Seeking advice from an accountant, tax advisor, or business consultant experienced in company closures is highly recommended to ensure compliance with all legal and financial requirements.

Can a director’s loan be written off?

Under certain circumstances, a director’s loan can be written off. However, it’s important to note that this process involves specific legal and tax considerations. Writing off a director’s loan should be done following appropriate procedures and with proper documentation to avoid any potential issues with the company’s financial records or tax liabilities.

So, the short answer is yes you can write off a director loan account but before you start pilfering the company bank account you need to get a firm grasp of the tax and accounting rules around such a transaction. 

Writing off a Directors Loan account, will depend on various factors, including the financial position of the company and the willingness of the directors to waive repayment. From an accounting perspective, if the company forgoes the loan and the director agrees, it can be treated as a write-off. However, it is crucial to consider the potential tax and accounting implications before making this decision.

Taking a loan from a company has many variables to consider, not all favourable and the timing of such transactions play a key role in whether this would work for you. 

We have put together a detailed guide on can you write off a director’s loan account to help you.

Can I close a Ltd company with debt?

Closing a limited company with debt is possible, but it requires careful consideration of various factors. If the company has outstanding debts, they should be properly managed and settled before initiating the closure process. Failure to address the debt may lead to complications during the company closure, such as creditor claims and potential personal liability for the directors.

You can close a limited company with debts, but you will usually need to have the agreement of your company’s directors, shareholders, and creditors to dissolve the business. Once the company is insolvent, the interest of your creditors legally come before those of directors and shareholders.

• You cannot dissolve a company if it has significant debts.
• You can only dissolve (Strike Off) a limited company if the following applies:
• The company has not traded for three months; this must be a genuine cessation of trade
• The company has no assets, property or cash at the bank.
• The creditors are informed, requesting their permission for the company dissolution.
• Creditors are given three months to consider the request to dissolve the company and can reject such a request.
• The company has not changed its name in this period.
• The company has not disposed of any property or assets (this may include land and buildings, plant and equipment, debtors and other assets).

If the above does not, then you cannot dissolve a company with debts and will need to go through a proper liquidation process.

We would recommend that you seek professional advice from an insolvency practitioner if you are considering closing a limited company with debts.

Before doing so check out our guide on closing a limited company with debts to ensure you understand the basics before speaking to an insolvency practitioner. You may also wish to consider getting an overview on the cheapest way to close a limited company before making any decisions.

Can directors be personally liable for limited company debts?

In general, the limited company structure protects directors from personal liability in relation to business debts. However, if a company is insolvent and the directors act or omit taking action which worsens the creditor’s position then they could be liable for debts arising from that point.

The specific transactions that will be of interest to the liquidator in determining liability that can have a direct financial consequence for the Directors:

• Directors Loan Accounts
• Undervalued Transactions
• Preferential Payments
• Unlawful Dividend Payments
• Personal Guarantees
• Fraud and misrepresentation
• Inaccurate record keeping

Section 214 of the Insolvency Act refers to ‘wrongful trading’ — the term used to describe scenarios where a company director fails to put the interests of creditors first while knowing the business was insolvent.

Wrongful trading does not necessarily reflect a conscious desire to defraud creditors; it can occur due to a misunderstanding or lack of awareness about the correct procedures to follow.

If a limited company is in financial trouble or becomes insolvent and goes into liquidation, its directors have a legal duty to protect creditor interests.

Failure to do so can expose the directors to personal liability for the company’s debts.

You may wish to read our guide on what your responsibilities are as a director of a limited company for more information.

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

If a director is unable to repay their loan to the company, it is considered an overdrawn loan. In such cases, the director may face tax implications, including potential tax charges on the overdrawn amount. It is essential to consult with a tax professional to understand the specific consequences and explore suitable solutions.

The outstanding loan amount may be subject to income tax and National Insurance Contributions (NICs) for the director, treated as employment income. 

Additionally, the company may face potential tax consequences, such as the application of the s455 tax charge calculated and paid as part of the Corporation Tax return.

See a full breakdown of the potential reporting and tax charges of what happens if you can’t pay back a director’s loan.

Can you strike off a company with an overdrawn director’s loan account?

Striking off a company with an overdrawn director’s loan account is possible, but it requires careful consideration of the legal and tax implications. Before initiating the strike-off process, the overdrawn loan should be properly addressed. Failure to do so may result in the company being restored to the register and potential personal liability for the directors.

To strike off a company an advert is placed in the Gazette allowing any creditors to come forward and put a stop to the process. If you have an overdrawn director’s loan account, it might imply that the company owes HMRC tax due on the overdrawn director’s loan.

You or your company may have to pay tax if you take a director’s loan as the vehicle for borrowing money from your limited company.

Your personal and company tax responsibilities depend on how the loan is settled.

As this is a complex area we would advise you to consider whether you need an accountant to close your business.

FAQs on closing a company with an outstanding director’s loan

What’s the best way to get rid of a director’s loan?

To eliminate a director’s loan, several options can be considered. 

Firstly, the director can repay the loan using personal funds or any other legal means. Secondly, the company can declare dividends to the director if they are also a shareholder, using the funds to offset the loan balance. Lastly, the director and the company can agree to write off the loan, as discussed earlier.

Examples of repaying a director loan account could be forgoing the cash settlement of business mileage and business expense claims perhaps offsetting the cash with the DLA instead.

As suggested above a dividend could be voted and not paid because the cash has already been received in the form of the loan. Be aware that the dividend will incur an income tax charge when you submit your self-assessment tax return. How will you pay for that? You can end up in a vicious circle taking further loans and dividends to settle the previous year’s tax bill. 

What happens if in subsequent years the company does not perform as well. Will it be able to vote a dividend to clear a Directors Loan Account? Using a DLA as a means of funding your day-to-day lifestyle would never be advisable.

The most suitable approach depends on the individual circumstances and should be discussed with professional advisors.

Can’t pay back my director’s loan: What are the options?

If a director is unable to repay their loan, it is crucial to communicate and discuss the situation with the other stakeholders involved, such as fellow directors, shareholders, or creditors. Exploring options like renegotiating repayment terms, seeking financial assistance, or considering alternative arrangements can help alleviate the situation.

Company owes director money: What can be done?

If a company owes money to a director, it is essential to properly document this as a valid debt owed to the director. The company should aim to repay the debt within a reasonable timeframe, ensuring that the transaction is properly recorded and compliant with relevant laws and regulations.

Overdrawn director’s loan and company liquidation

An overdrawn director’s loan can complicate the process of company liquidation. The liquidator will examine the company’s financial records, including the director’s loan account, and take appropriate action to address any overdrawn amounts. The director may be required to repay the loan or face potential legal and tax consequences.

Company owes director money: Write-off options

Under certain circumstances, a company may write off the debt owed to a director. However, this should be done following proper procedures and with the guidance of professional advisors to ensure compliance with legal and tax requirements.

You may wish to consult with an accountant as there may be tax relief available to the director to offset other capital gains in the future.

Can a director loan money to his company?

Yes, a director can loan money to their company. However, this transaction should be properly documented, including the terms of repayment, to establish the loan as a valid debt owed by the company to the director.

You can put your own money into a business and limited company. It can be done as an investment through share capital, a loan to fund business activities, interest on a loan from the company or a gift.

Making a loan to the company may be a preferable option compared to applying for a commercial loan from your bank – it’s a cheaper way of putting personal money into a limited company due to no interest being applied.

It is also often a lot quicker to loan personal money to your company than dealing with a high street lender. We know it can be uncomfortable and time-consuming discussing financial matters especially if you have funds available yourself.

Any loans are recorded in the company directors’ loan accounts. In all cases, we recommend you create a loan agreement between the director(s) and the limited company – which are distinct legal entities.

The agreement should detail the loan size, interest rate, term, and any other conditions. 

There is no obligation to do this, but it creates a paper trail which may prove useful in the future and provide the finance team with details on how to process transactions in the accounting records to match.

Although it is unlikely if you have used model formation documents, make sure that your Articles of Association don’t prevent loans being made from the company’s directors.

Director’s loan calculator and tax relief

A director’s loan calculator can help estimate the tax implications of an overdrawn loan. Additionally, there may be tax relief available on certain director’s loans, such as loans provided for specific business purposes. Consulting with a tax professional can provide insights into available tax relief options.

Director’s loan less than £10,000: Considerations

Loans of less than £10,000 from a director to their company may have fewer tax implications. However, it is essential to maintain accurate records, ensure compliance with regulations, and consult with professionals to fully understand the implications and available options.

When a director of a company loans less than £10,000 to the company, there are several considerations to keep in mind:

1. Companies Act 2006: The Companies Act 2006 in the UK regulates director’s loans. If the loan amount is less than £10,000, it is considered a “small” loan and can have some differences in treatment compared to larger loans.

2. Loan Agreement: Even though it’s a small amount, it is still essential to have a written loan agreement in place. This agreement should outline the terms of the loan, including the amount, interest (if any), repayment schedule, and any other relevant terms.

3. Arm’s Length Transaction: The loan should be made on an arm’s length basis, meaning it should be similar to what an independent third party would offer in similar circumstances. Otherwise, there may be potential tax implications.

4. Benefit-in-Kind (BiK) Tax: In the UK, if the loan exceeds £10,000 at any point during the tax year, the director may be subject to a benefit-in-kind tax on the outstanding amount. However, since the loan is less than £10,000 in this case, this tax should not apply.

5. Interest-Free Loans: If the director’s loan is interest-free or has an interest rate below the official HMRC rate (known as the “official rate of interest”), there may be tax implications. The difference between the interest charged (if any) and the official rate might be considered as taxable income for the director.

6. Record Keeping: Proper records of the loan transaction should be maintained, including the loan agreement, repayment schedule, and any other related documents.

7. Repayment Plan: The director should have a clear plan for repaying the loan according to the agreed-upon schedule.

8. Financial Impact on the Company: Even though it’s a small amount, the company’s financial position should still be considered. Taking loans can affect the company’s cash flow and financial stability.

10. Potential Conflict of Interest: If the director has a significant influence on the company’s financial decisions, it’s essential to ensure that the loan transaction is transparent and does not present any conflicts of interest.

For individual cases, it’s always best to consult with a qualified accountant or financial advisor who can provide tailored advice based on the latest rules and regulations.

Conclusion

Closing a company with a director’s loan requires careful consideration of legal, financial, and tax implications. It is crucial to seek professional advice from accountants and tax specialists to navigate this complex process effectively.

Properly addressing an overdrawn loan, documenting debts owed by the company to directors, and complying with legal and tax obligations will help ensure a smoother closure process and mitigate potential risks and liabilities.