What is an Overdrawn Director’s Loan Account?

Posted 24th May 2021

As expert accountants for small businesses, we handle many different scenarios involving directors’ loans. Most small business owners and directors of private limited companies will at some point find themselves with an overdrawn Director’s Loan Account (DLA)—which simply means owing money to the company.

For many business owners, an overdrawn DLA is a temporary position resulting from drawing funds throughout the year before officially declaring a dividend. A routine paperwork task, properly voted board minutes, and dividend vouchers will usually clear the overdrawn position, returning the account safely into credit.

However, when business cash flow is strong, it can create the illusion of high retained profits. Without up-to-date monthly accounts, it is easy to mistake cash sitting in the bank for distributable profit—when in reality, those funds may be owed to HMRC for VAT or Corporation Tax, or to key suppliers. Taking money out in this scenario leads to an unintentional overdrawn loan account that must be repaid or formally settled to avoid severe tax penalties.

Key Tax Complications of Overdrawn Director’s Loan Accounts

Borrowing money from your own limited company carries strict tax and statutory obligations under UK tax law. If an overdrawn loan account is not managed correctly, both the company and the director face penal tax charges.

1. Section 455 Corporation Tax Charge

If a director’s loan remains overdrawn nine months and one day after the end of the company’s accounting period, the company must pay a special Corporation Tax penalty known as the Section 455 (S455) charge:

Loans advanced before 6 April 2026: Subject to a 33.75% Section 455 tax charge.
Loans advanced on or after 6 April 2026: Subject to a 35.75% Section 455 tax charge (tracking the increase in the upper dividend tax rate).

For example, if your DLA is overdrawn by £20,000 at the nine-month deadline, your company must pay £6,750 (at 33.75%) or £7,150 (at 35.75%) to HMRC alongside its Corporation Tax bill. While the company can eventually reclaim this tax from HMRC once the loan is repaid in full, the money remains tied up with HMRC for at least nine months after the accounting period in which the repayment occurred.

2. Clearing DLAs via Dividends & the £500 Dividend Allowance

Historically, directors would clear overdrawn loan balances at year-end by declaring dividends. However, with the tax-free Dividend Allowance sitting at just £500, declaring additional dividends to clear an overdrawn DLA will trigger personal Income Tax for the director on almost the entire dividend amount (at basic, higher, or additional rate). Furthermore, dividends can only legally be voted if the company has sufficient retained profits available.

3. Benefit in Kind (BIK) Charges on Interest-Free Loans

If the overdrawn balance exceeds £10,000 at any point during the tax year, and the director does not pay interest to the company at or above HMRC’s official rate (currently 3.75%), the loan is classed as a cheap or interest-free loan. This triggers a Benefit in Kind (BIK) charge, requiring:

The director to pay personal Income Tax on the deemed interest through Self Assessment.
The company to pay Class 1A National Insurance contributions on the benefit value.

4. Writing Off a Director’s Loan

If a company decides to write off or waive an overdrawn director’s loan, the write-off triggers significant tax consequences:

Personal Income Tax: The amount written off is treated as a distribution (deemed dividend) or income, taxable personally on the director through Self Assessment.
National Insurance: The company must pay Class 1A National Insurance on the written-off amount.
No Corporation Tax Relief: The loan write-off is not an allowable expense for Corporation Tax purposes, meaning the company gets no tax deduction for writing off the balance.

5. Beware HMRC’s “Bed and Breakfasting” Rules

HMRC actively monitors artificial loan repayments designed solely to avoid the Section 455 charge. Under “bed and breakfasting” anti-avoidance rules, if a director repays a loan balance over £5,000 to avoid the nine-month deadline and then withdraws a similar sum within 30 days, HMRC ignores the repayment and applies the Section 455 tax charge regardless.

How to Avoid Director’s Loan Account Traps

We advise all our limited company clients to exercise prudence when drawing funds out of their business. To maintain a healthy financial position:

Implement real-time management accounts to know your exact distributable profit reserves before making withdrawals.
Structure regular, planned salary and dividend schedules rather than making ad-hoc personal bank transfers.
Set aside dedicated tax reserves for VAT, Corporation Tax, and PAYE so company cash isn’t mistaken for profit.

Expert Director’s Loan Advice from MNE Accounting

If you are concerned about an overdrawn Director’s Loan Account, Section 455 tax exposure, or optimizing your personal extraction strategy, our team of small business accountants is here to help.

Need expert guidance on managing your company accounts or tax planning? Contact MNE Accounting today or call 0116 255 2422 to speak with our tax team.

Frequently Asked Questions About Director’s Loan Accounts

What is the Section 455 tax rate on overdrawn director’s loans?

The Section 455 tax rate is 33.75% for loans advanced before 6 April 2026, rising to 35.75% for loans advanced on or after 6 April 2026. It applies if an overdrawn loan account is not repaid within nine months and one day of the company’s financial year-end.

Can my company reclaim Section 455 tax after the loan is repaid?

Yes. Once an overdrawn director’s loan is repaid, written off, or settled via a voted dividend, the company can reclaim the Section 455 tax previously paid to HMRC. The reclaim is processed nine months and one day after the end of the accounting period in which the repayment occurred.

What is the tax threshold for an interest-free director’s loan?

A director can borrow up to £10,000 from their limited company tax-free without triggering a Benefit in Kind (BIK) charge, provided the balance stays under £10,000 at all times during the tax year and is repaid within nine months of year-end. If the balance exceeds £10,000, interest must be charged at HMRC’s official rate to avoid a BIK charge.