Tax implications of an overdrawn Director’s Loan Account 14 March 2021

RMcH states: if you have your own company it's important to understand the issues around extracting money in terms of directors loans (generally forbidden)  and expenses, this article concentrates on the area of directors loans what is allowed and what is not allowed

Taking money from the business for personal use when trading as a sole trade or partnership is fairly painless and unless proprietors’ drawings are a major drain on the business’ assets, there are generally no tax implications.

A company on the other hand is a separate legal entity, and therefore, making withdrawals requires far more consideration.

In this article, we take a closer look at the consequences on overdrawn director’s loan accounts.

Tax implications of an overdrawn Director’s Loan Account

If a payment is made to a director and it does not form part of the director’s remuneration package or is not an allowable expense for the company, the payment must be set against their director’s loan account. If the director has a credit balance available on their director’s loan account i.e. the company owes the director some money, then the director can set such a payment against their loan account with no tax implications.

However, once the monies owed to the director are exhausted, any further funds that they take from the company mean that the director owes money back to the company and is therefore a debtor of the company. This can have two implications:

1. Corporation Tax Charge

Firstly, if a balance remains outstanding on their loan account at the company’s year end, this can lead to an income tax charge on the company. The income tax charge is 20% of the total benefit. So for example if there is a loan balance of €80,000 the total benefit is treated as €80,000/80% = €100,000.  The company must then pay €20,000 to the Revenue as an income tax charge. If the director repays this within 4 years the company can request a refund of this income tax payment from Revenue.

2. Benefit in Kind

The second implication of an overdrawn director’s loan account is that it can trigger a benefit in kind. As mentioned above, an overdrawn director’s loan account is effectively an interest-free loan. The benefit would be equal to the interest that would have been charged by an unrelated party (the calculation of which is stipulated by Revenue). 

If the loan is not repaid are forgiven by the company the director will be liable to income tax on the full amount of the loan. The company is not entitled to any tax deduction for the forgiveness of this loan.

Company law implications of an overdrawn Director’s loan

A potentially more serious implication of an overdrawn director’s loan account is the company law restrictions.  Under company law it is illegal for a company to loan more than 10% of its net assets to their directors.  If this restriction is not complied with the directors can be prosecuted by the Office of the Director of Corporate Enforcement (ODCE).

Record Keeping and Disclosure

Good record keeping with regards to a director’s loan account is essential. Poor records could result in the misallocation of expenses/ payments and ultimately, the right taxes not being paid.

Good records are also important, because disclosure of the balance on each overdrawn director’s loan account must be made in the company’s accounts.

Overall, the key is to keep timely, accurate records and to keep the transactions relating to each of the directors separate.

So what’s the best solution for dealing with an overdrawn Director’s Loan Account?

As with a lot of scenarios, it’s hard to give one solution that will suit everyone’s circumstances.

If the director is unable to repay the director’s loan account then the company may be able to put the loan through as an additional salary. The company will have to pay PAYE/PRSI on this salary.

If the company has a net worth, an excess of assets over liabilities, it may be possible for the director to take a loan once the amount does not exceed 10% of the net assets at the date of the loan. However, an application must be made to the company's registration office, termed a summary approval procedure (SAP), this application must be made within 14 days from the date of the loan extraction.

Also, any assets in use for the purposes of carrying on the trade of the business, which are owned by the director may be sold into the business, current market value rules apply and the director's loan can be credited for this amount.  However due consideration should be given to the CGT, capital gains tax position of the director in terms of making a personal disposal into the company.