If you take a large proportion of remuneration as dividends as a business owner, it is important to ensure there are sufficient profits within the business. In a previous article, we discussed the importance of reviewing remuneration policies for owner managed businesses (OMBs), particularly during a time of economic changes. In this follow-up, Brett Barton, Business Recovery and Restructuring Partner, explores what can happen if an OMB has overdrawn loan accounts, and how to avoid the problems this causes.
The problems owner managed businesses face
There is a significant amount of red tape involved with the day-to-day running of the business. Sometimes, usually in OMBs, preparing the paperwork required by the Companies Act 2006 to declare a dividend can be forgotten as a priority. Our business recovery and restructuring team often encounter directors who are unaware that withdrawing money from the business classifies as a loan and does not form part of their wages. With the introduction of Real Time Information (RTI) in 2013, it is also impossible to retrospectively declare wages subject to the normal deductions of PAYE and NIC. Instead, the accounting treatment of drawings is to debit the bank and to create a loan account.
A further problem that our team often encounter is a timing issue, in which a business may have been profitable during the time the withdrawals were made With businesses having nine months to complete and file the accounts for their accounting period, there is a chance the fortunes of a business can change, altering the ability to declare a dividend to reduce any overdrawn loans in their account.
An example of how an overdrawn director’s loan can impact a business
The recent case study outlined below demonstrates what could happen in this instance.
Company A has a year-end of 30th November 2019 with their accounts showing that during the year notional salaries have been declared via RTI under PAYE of £40k. Company A made profits of £472k for the period and the business owners considered declaring dividends of £400k to unravel drawings, which had been received during the period, of £207k.
However, they decided to delay the declaration of the dividends to ensure that the net reserves of the company were maintained, as they were working on a large project at the time and didn’t want their credit rating with their suppliers to be affected.
Unfortunately, all the projects that Company A were working on were postponed overnight due to the Covid-19 pandemic. Company A was not able to recover from the impact of the pandemic and it entered into Administration on 4th September 2020.
The insolvency practitioner wrote to the director and asked for the repayment of the overdrawn director’s loan account. A number of arguments were raised by the legal representatives of the director, including an assertion that the intention to declare the dividend and/or the remuneration should be set off against the claim.
The legal advice received in this case was that these arguments were not valid, and legal action was therefore taken. The insolvency practitioner did not have any funds in the case, but solicitors were prepared to act on a CFA, and ATE insurance was obtained to support the legal action. The director then agreed a settlement to pay a significant proportion of the ODLA to avoid it going to trial.
How we can help OMBs with Overdrawn Director’s Loan Accounts
It is important for business owners to understand that any money withdrawn from a business will need to be repaid if it becomes insolvent. The problems that arise can be avoidable, by eliminating withdrawals and ensuring that all wages are declared and paid each month.
If you have been taking drawings from your business and are concerned that you may struggle to repay your loan balance, get in touch with a member of our business recovery and restructuring team to find out how we can assist you.
