In more than 75% of our enquiries from directors of struggling companies, we find that this is a major problem. So what is an "overdrawn director's current account?"
Well, usually the company is making some profits and accountants advise their clients to save tax by paying themselves a small salary and then taking dividends from the reserves of profits made in the past and current years.
THEN something goes wrong!
Although the advice is generally sound from a tax reduction perspective, when a company is performing well; If the business starts to perform badly then directors can end up with serious personal liability problems.
Having an overdrawn director's current account is actually a breach of the Companies Act 2006. All accounts filed at Companies House should refer to any overdrawn current accounts as loans to the director concerned. The directors must try and get these paid back or reversed in subsequent periods as HMRC will tax on a fairly penal rate if you do not. If the company has no distributable reserves, it cannot pay dividends. So, if your company's balance sheet starts a year with nil or negative reserves, then if you make no profit then the direcotors must not take dividends as soon as they are aware of this.
It is much better to pay through PAYE and pay the tax/NIC. If the company cannot afford to pay GROSS then it is likely to be insolvent.
What can we do? Options include:
Repaying the debt personally owed to the company. Offseting any loans the directors have made to the company (this is called set off). Taking a full salary but reduce the cash taken out of the business to gradually offset the account. So pay yourself £4,000 per month but take £1,000. Remember to pay tax on the £4,000! Making lots of profits in future periods to offset it!
What happens in liquidation if we have overdrawn current accounts?
In liquidation, the liquidator can demand that directors repay their overdrawn director's current account to the company for the benefit of the creditors. They can take legal action to make directors pay this or even make the directors bankrupt.
This means that directors could lose their house if the directors current account is overdrawn and not recovered.
Read our case study on how this can happen and what can be done about it
He is managing director of Company Rescue Ltd and KSA Group Ltd - a specialist firm of turnaround practitioners. Keith has been featured in Mike Southon's column in the Financial Times and his book - This is How Yoodoo on entrepreneurs.
More than 5,000 people have contacted KSA Group since Keith launched this...