Director’s loan accounts and dividends – not always the best option

While many accountants advocate using director’s loan accounts and dividends as a tax efficient way of paying remuneration, this may not always be advantageous, particularly when a company is making losses.

“We all want to get paid for the work we do while also paying the minimum amount of tax on what we earn,” explains Peter Sargent, partner at rescue and recovery specialist Begbies Traynor in Halifax. “Traditionally, accountants have tended to recommend paying dividends from the profits of a limited liability company. The cunning plan allows the director or shareholder to draw regular sums from their company and charge them to their loan account.

“In many cases, the director’s loan account will become overdrawn; to rectify the situation and to avoid paying tax on this perceived benefit in kind the director or shareholder will vote themselves a dividend which is set off against the loan account. This is all very well when the company is making profits and has reserves from which a dividend can be paid. However, the plan unravels when the company’s reserves have not been replenished by profits, but instead have been exhausted by losses and dividends taken. As a result, the director has an overdrawn director’s loan account on which tax has to be paid.”

Mr Sargent continues, “If the company’s fortunes don’t improve, the situation can escalate. The company may ultimately fail and find itself faced with administration or liquidation. The company’s balance sheet will then show that the director owes the company money and the insolvency practitioner will take steps to recover these funds from the director.

“Furthermore, often directors of SMEs will have given personal guarantees to banks, other lenders and some trade creditors. On failure, these creditors will demand payment from the director. Banks often have charges over the domestic property of the director and could, if they so wished, force a sale.

“The unfortunate director, could find himself without a business, without a roof over his head and, in extreme circumstances, bankrupt. So, while paying remuneration by dividend can be a good idea, it is vital that directors are aware that if profits start to dip, dividends may not be the best way to be remunerated.”