Director’s Loan on Liquidation: What Happens to an Overdrawn DLA?
A director’s loan on liquidation does not simply disappear when the company closes. An overdrawn director’s loan is normally an asset of the company and may need to be repaid, set off against amounts due to the shareholder, or formally dealt with by the liquidator.
The tax treatment can be very different depending on whether the company enters a solvent Members’ Voluntary Liquidation or an insolvent liquidation, and whether the loan is repaid, set off, released or written off.
What Happens to a Director’s Loan on Liquidation?
HMRC states that an overdrawn director’s loan account represents a receivable and is therefore an asset of the company.
Liquidation does not automatically cancel that asset. If the director owes the company money, the liquidator will need to consider how that debt should be dealt with.
The ultimate treatment can include repayment, set-off against a liquidation distribution, formal release, write-off or continued recovery action, depending on the circumstances.
An Overdrawn Director’s Loan Belongs to the Company
This is one of the most important points to understand before liquidation begins.
Director Borrowed Funds
The accounting records show an amount recoverable from the director.
Balance Sheet Asset
The overdrawn loan appears as an amount due to the company.
Liquidator Takes Control
Once appointed, the liquidator deals with the company’s assets, including amounts owed by directors.
Debt May Be Pursued
The liquidator can seek repayment where the loan remains legally due.
Set-Off May Be Relevant
In suitable circumstances, mutual amounts due can potentially be settled by set-off.
Tax Still Needs Reviewing
s455 relief and the director’s own tax position must be considered separately.
MVL vs Insolvent Liquidation
The treatment of a director’s loan on liquidation can differ substantially depending on whether the company can pay its creditors.
Members’ Voluntary Liquidation
In an MVL, the company is solvent and shareholders can become entitled to capital distributions from the net assets after liabilities have been dealt with.
Insolvent Liquidation
Where the company cannot meet its debts, the director’s loan remains an asset available for the liquidator to consider recovering for creditors.
How an Overdrawn DLA Can Be Dealt With in an MVL
HMRC’s current guidance recognises that once a solvent company enters liquidation, the shareholder may be entitled to a proportion of the company’s net assets.
At the same time, the shareholder may owe money back to the company through an overdrawn director’s loan account.
Instead of physically paying both amounts in opposite directions, it may be possible for the liquidator to set the shareholder’s entitlement against the debt owed to the company.
Using a Liquidation Distribution to Clear an Overdrawn DLA
This is a simplified illustration. The liquidation, shareholder, tax and legal position must be reviewed before applying set-off.
HMRC states that where the shareholder’s liquidation entitlement is properly set against the DLA, the debt is discharged by satisfaction.
MVL Set-Off Can Avoid Treating the DLA as a Loan Release
HMRC’s MVL guidance distinguishes a genuine set-off from the company simply releasing the shareholder from the loan.
In HMRC’s analysis, an appropriate set-off constitutes repayment for section 458 purposes because the creditor receives something of equal value in satisfaction of the debt.
That can be materially different from a loan being formally written off or released.
Liquidation Distributions Can Receive Capital Treatment
HMRC states that distributions of assets to shareholders in a winding-up are generally capital distributions for Capital Gains Tax purposes rather than ordinary company dividends.
Whether Business Asset Disposal Relief or another relief is available depends on the shareholder meeting the relevant statutory conditions.
Capital treatment should not be assumed automatically because the winding-up targeted anti-avoidance rules can apply in certain cases.
Can a Liquidator Recover an Overdrawn Director’s Loan?
Yes. An overdrawn director’s loan is money owed to the company and can form part of the assets available to an insolvency practitioner.
HMRC expressly states that once liquidation starts, an administrator or liquidator may seek repayment of outstanding loans.
The Insolvency Service also identifies overdrawn director’s loan accounts as an example of money owed to an insolvent company that may need to be collected.
What If the Director Does Not Have the Money?
Inability to repay does not itself make the debt disappear.
Debt May Still Be Pursued
The liquidator can consider recovery of the amount due to the company.
Financial Position Reviewed
Recoverability can depend on the director’s assets, income and circumstances.
Settlement May Be Considered
A liquidator may consider an appropriate settlement where commercially justified.
Balance May Be Released
A formal release or write-off can have separate tax consequences.
Personal Advice May Be Needed
Significant debts can raise wider legal or insolvency issues for the individual.
Tax Position Still Remains
Any release should be reviewed for Income Tax and National Insurance consequences.
A formal release or write-off can relieve the company of the outstanding receivable, but that does not normally mean the shareholder receives the benefit tax-free.
What Happens If the Liquidator Writes Off the Director’s Loan?
HMRC states that where an s455 loan is released or written off, section 458 relief can become available to the company.
However, the amount released or written off can then be included in the borrower’s income under the close-company loan rules.
HMRC also states that Class 1 National Insurance can apply where the relevant conditions are met.
Paying Less Than the Full Loan Can Still Create a Write-Off
HMRC specifically addresses situations where a liquidator accepts a partial payment in full and final settlement of a larger director’s loan.
Where the agreement extinguishes the remaining debt, HMRC treats the unpaid balance as released or written off.
The tax consequences of the forgiven portion therefore need to be considered separately from the amount actually paid.
Tax consequences of the £40,000 require separate review.
What Happens to s455 When the Company Goes Into Liquidation?
Liquidation does not by itself erase the historical s455 position.
HMRC states that where the relevant loan is repaid, released or written off, section 458 relief can become available and the corresponding s455 tax can be repaid or discharged.
The precise treatment depends on what actually happens to the loan, rather than simply the fact that liquidation has started.
Read Reclaiming s455 Corporation Tax →Do Not Forget Any s455 Refund Due to the Company
Where a company has already paid section 455 tax, resolving the director’s loan may create a Corporation Tax recovery that should form part of the liquidation accounting.
Why Solvency Can Change the Tax Analysis
Sufficient Net Assets
A shareholder’s liquidation entitlement can potentially be used to satisfy an overdrawn DLA by set-off.
Key distinction HMRC can treat genuine set-off as repayment rather than loan release.No Sufficient Distribution
The director can remain liable for the debt even though the company itself has no distributable net assets.
Key distinction If an unrecovered balance is released or written off, the borrower can face an Income Tax charge.A Company Owing the Director Money Is the Opposite Position
If the director has previously lent money to the company and the loan account is in credit, the director may instead be a creditor of the company.
That should not be confused with an overdrawn DLA where the director owes money back to the company.
In an insolvency, the director’s ability to recover money owed by the company will depend on the normal creditor and insolvency rules.
Director’s Loan Review Before an MVL or Insolvency Appointment
A bookkeeping entry cannot by itself turn a genuine debt into something that no longer exists.
The DLA Should Be Correctly Resolved Before the Final Accounts
Dividends require sufficient distributable profits and proper declaration. Remuneration can require PAYE and NIC. A loan release or write-off has its own tax consequences.
Where liquidation is contemplated, adjustments to the director’s loan should therefore reflect genuine transactions and should be coordinated with the insolvency practitioner where appropriate.
Accountant, Tax Adviser and Insolvency Practitioner
Accountant
Reconcile the DLA, company accounts, tax balances and historic transactions.
Tax Adviser
Review s455, s458 relief, shareholder taxation and relevant Corporation Tax reporting.
Licensed Insolvency Practitioner
Conduct the liquidation and determine how company assets and creditor claims are dealt with.
Related Director’s Loan Guides
Get the Accounting and Tax Position Ready Before Liquidation
Accurate accounts and a reconciled director’s loan can make it much easier for the insolvency practitioner and tax adviser to determine the correct treatment.
Director’s Loan & Liquidation Resources
Director’s Loan on Liquidation FAQs
What happens to a director’s loan when a company goes into liquidation?
An overdrawn director’s loan is normally an asset of the company. The liquidator therefore needs to consider its recovery or other proper treatment rather than simply removing it from the accounts.
Does an overdrawn director’s loan disappear in liquidation?
No. Liquidation itself does not cancel the debt owed by the director.
Can a liquidator ask the director to repay the loan?
Yes. HMRC and Insolvency Service guidance both recognise an overdrawn director’s loan as an amount owed to the company that can be considered for recovery.
What happens to an overdrawn DLA in an MVL?
In a solvent MVL, a shareholder may be entitled to capital distributions. In suitable circumstances that entitlement can potentially be set against the amount the shareholder owes to the company.
Is an MVL set-off treated as a loan write-off?
HMRC’s guidance states that an appropriate set-off of mutual debts can constitute repayment by satisfaction rather than release or write-off.
What happens if the director cannot repay the loan?
The debt does not automatically disappear. The liquidator will consider recoverability and may pursue repayment or decide on another appropriate course based on the circumstances.
What if the liquidator writes off the director’s loan?
Section 458 relief can potentially arise for the company, but the amount released or written off can create an Income Tax charge on the borrower and National Insurance may also require consideration.
Can the company reclaim s455 during liquidation?
Where the relevant loan is repaid, released or written off, section 458 relief can potentially allow the associated s455 tax to be recovered or discharged.
Is a liquidation distribution taxed as a dividend?
Distributions in a winding-up are generally treated as capital distributions for shareholder tax purposes, although relief conditions and the winding-up anti-avoidance rules must also be considered.
Can the accountant decide how the liquidator treats the loan?
No. The accountant can establish the accounting and tax position, but the appointed liquidator is responsible for administering the company’s assets and the liquidation itself.
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