An overdrawn director’s loan account is money the director owes the company, so when the company is liquidated it becomes an asset the liquidator must collect for creditors. Liquidation does not cancel the debt. A director who cannot repay may face a court claim, a bankruptcy petition or, if the debt is formally released, an income tax charge on the amount written off.

Why does a liquidator pursue an overdrawn loan account?

A liquidator’s job, as section 143(1) of the Insolvency Act 1986 puts it for a court winding up, is to secure that the company’s assets are got in, realised and distributed to creditors. The Insolvency Service’s guide to liquidation lists collecting money owed to the company as one of the core steps. A director’s loan account in debit is exactly that: a debt owed to the company, recorded on its balance sheet, by someone the liquidator can usually find.

In many small company failures the loan account is one of the largest recoverable assets, because the other assets are stock, debtors and equipment already sold or charged to a lender. Creditors, including HMRC, will expect the liquidator to investigate it. Our page on the director’s loan account explains how the account builds up in normal trading.

How does the liquidator work out what is owed?

The starting point is the company’s own records: the nominal ledger, the last filed accounts and any draft accounts, bank statements and the CT600A supplementary page of the Company Tax Return, which shows loans to participators outstanding at the end of an accounting period. The liquidator will compare these and look for:

  • personal spending paid from the company account and not reimbursed
  • drawings recorded as “dividends” when the company had no distributable profits
  • year end journals that reduced the balance without cash moving
  • repayments made shortly before a new withdrawal, which may show the balance was never really cleared

The director will be asked to explain the balance. If they say it was cleared by dividends, the liquidator will check whether those dividends were lawful. A dividend paid without distributable profits is unlawful, and a shareholder who knew or had reasonable grounds to believe that can be required to repay it, which simply puts the debt back. Our page on unlawful dividends covers this.

What legal routes can a liquidator use to recover it?

  • Debt claim. The simplest route is a demand followed by court proceedings for the balance as a debt.
  • Misfeasance. Under section 212, where an officer has misapplied or retained company money or breached a duty, the court can order them to repay or contribute compensation, with interest at such rate as the court thinks just.
  • Loans made without members’ approval. Section 197 of the Companies Act 2006 requires a members’ resolution before a company lends to its director, subject to exceptions. Where it was needed and not obtained, section 213 makes the transaction voidable and makes the director, and any other director who authorised it, liable to account for gains and indemnify the company for loss. See loans to directors and member approval.
  • Bankruptcy. If the director does not pay, the liquidator can serve a statutory demand. Under section 268 a debtor who has neither paid nor had the demand set aside after three weeks is treated as unable to pay, and under section 267 a creditor’s petition can be presented where unsecured debts equal or exceed the bankruptcy level, currently £5,000.

Can I set off money the company owes me?

Often, yes. Rule 14.25 of the Insolvency (England and Wales) Rules 2016 requires an account to be taken of mutual dealings between the company and a creditor before liquidation, with the sums due each way set off. Only a net balance owed to the director can be claimed in the liquidation, and a net balance owed to the company must be paid to the liquidator.

So if the director genuinely lent money to the company on a separate occasion, or is owed unpaid salary or expenses under a real obligation, those amounts reduce the overdrawn balance. The rule excludes debts the creditor took on, or acquired by assignment, after they had notice that a decision on nominating a liquidator had been sought or a winding up petition was pending. A director cannot buy up a supplier’s claim on the eve of liquidation to cancel their own debt.

Set off needs evidence. A credit entry made after the event with no underlying invoice, payslip or loan agreement will be challenged.

What are the tax consequences?

Two charges can be in play, and they are often misunderstood in an insolvency.

Section 455 tax on the company. For a close company, a loan to a participator still outstanding nine months after the end of the accounting period triggers a corporation tax charge under section 455 of the Corporation Tax Act 2010. GOV.UK gives the rate as 33.75% of the outstanding amount for loans made on or after 6 April 2022 (32.5% before). Section 458 gives relief when the loan is repaid, released or written off, claimable within four years from the end of the financial year in which that happens and not given until nine months after the end of the accounting period of the repayment or release.

Income tax on the director if the debt is released. If the liquidator agrees to release or write off part of the debt, section 415 of the Income Tax (Trading and Other Income) Act 2005 charges income tax on the amount released, and section 19 of the Income Tax Act 2007 treats it as dividend income. GOV.UK states that where a director’s loan is written off or released, including when the company goes into liquidation, Class 1 National Insurance must be dealt with through payroll and the director pays income tax through Self Assessment. A settlement for less than the full balance therefore has a personal tax cost as well as a cash cost.

What options does a director have?

  1. Repay in full. This ends the claim, and the company becomes entitled to section 458 relief on any section 455 tax it paid.
  2. Agree the balance first. Check every entry, identify credits for genuine sums the company owed you, and put the evidence to the liquidator before discussing payment.
  3. Negotiate a settlement or instalment plan. Liquidators weigh the cost and risk of litigation against what can be recovered. A realistic offer backed by a statement of personal means is often accepted, but remember the tax on any amount released.
  4. Raise genuine defences. If entries are wrong or relate to payments that were really business expenses, say so early with documents.
  5. Consider personal insolvency options. Where the balance is far beyond what you can pay, an individual voluntary arrangement or bankruptcy may be the outcome. Take independent advice; the liquidator acts for the creditors, not for you.

How might this look in practice?

Illustration only. A company enters creditors’ voluntary liquidation. Its records show the director’s loan account overdrawn by £40,000. The director shows that the company never paid her final two months’ salary of £6,000 under her service contract, and that she paid a £2,000 supplier invoice personally a year earlier.

  • Under rule 14.25 the £8,000 owed to her is set off, reducing the debt to £32,000.
  • She offers £20,000 over 12 months. The liquidator accepts and releases the remaining £12,000.
  • The £12,000 released is taxed on her as dividend income under section 415, and the company should account for Class 1 National Insurance on it.

What mistakes do directors make?

  • Assuming liquidation cancels the loan account. It does not; the debt is an asset of the company.
  • Clearing the balance with backdated dividends or bonuses when there were no profits or no cash to pay them.
  • Repaying the loan account just before liquidation with money borrowed again shortly afterwards. HMRC’s bed and breakfasting rules may also apply.
  • Having the company repay a director’s own credit balance while it is insolvent, which a liquidator can attack as a preference.
  • Ignoring letters. Silence makes a bankruptcy petition more likely and leaves the liquidator to rely on the company’s figures alone.

For how an overdrawn account fits with the other ways a director can become personally liable, see when directors are personally liable.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.