Directors’ Loan Accounts are a hidden risk during Insolvency!Posted: Feb 10, 2026

As Insolvency Practitioners, we know from years of experience that when a UK business starts to struggle financially, there are some repeated mistakes. These are often understandable and sometimes a result of misapplying the advice they were given in the past. One of these is the use of directors’ loan accounts. Don’t get me wrong on this, they are a useful tool for directors when used correctly. However, they are often also treated in a sort of casual way that causes problems later. Therefore, we often see well meaning directors who take money out with the full intention of ‘sorting it later’.

All this is not a problem as long as it is sorted later. When it isn’t, though, there can be some serious consequences. If the business becomes insolvent, an overdrawn directors’ loan account can be a source of some awkward personal, legal, and tax consequences for directors.

The recent case of Quillan v HMRC, highlights why directors must be extremely careful when dealing with directors’ loan accounts. It also highlights a hidden danger around post-insolvency settlements. They may seem fine at the time, but they can come back as a problem later.

Quick Reminder - What Is a Directors’ Loan Account?

A directors’ loan account (DLA) records money taken out of a limited company by a director that is not salary, dividends, or legitimate expenses.

What people sometimes forget is that if more money is taken out than paid back, the account becomes overdrawn. In short, that means the director personally owes money to the company. Which is not an issue as long as it is then paid back in an acceptable way.

While this is common in UK SMEs, it can become a major issue if the company later enters any kind of insolvency process.

Why Directors’ Loan Accounts Matter in Insolvency

As always, when dealing with legal matters, there is a fair amount of jargon thrown around, and every circumstance is different. So, we can only generalise in an article like this. Get advice, and get it early is always the best option.

Basically, under UK insolvency law, once a company is insolvent:

• The company’s assets must be used for the benefit of creditors

That means

• An overdrawn directors’ loan account is treated as a recoverable asset because, as the director who borrowed the money, you owe it back. You become the source of monies owed to the business, regardless of whether it was your business or not.
• An insolvency practitioner has a legal duty to investigate and pursue recovery

This means a director can be required to repay the loan personally, even if:

• The company has stopped trading
• The director no longer has access to company funds
• The business failure was unavoidable and not intentional

All of this can seem a remote possibility when the director is drawing from the business as a loan while the business is trading, but it is one of the most common areas where directors face unexpected personal exposure in insolvency.

Dividends and Directors Loan Account

One of the other areas where we see a Directors Loan Account problem occur is where a director has taken a minimum salary and dividends. This is common as it is often the most tax efficient way to draw funds from a company. This is fine where the Company has reserves to allow dividends.

However, as business finances become tight, directors sometimes don’t realise that dividends are no longer allowable and become payments against the directors’ loan account, which can lead to them becoming overdrawn.

A Common Scenario We See with UK Directors

A typical situation often looks like this:

A director of a UK limited company has been using their directors’ loan account to supplement income during a difficult trading period. The intention is to repay the money once cashflow improves. Unfortunately, the reality is the often trading conditions worsen and the company eventually reaches the insolvency stage.

During the insolvency process, the liquidator identifies an overdrawn directors’ loan account and requests repayment. The director, under pressure and keen to resolve matters quickly, agrees to a settlement for less than the full balance.

From the director’s perspective, the issue feels resolved.
The company is closed, the settlement has been paid, and life moves on.

This is all good in theory, and sometimes that will be the end of the matter… but not always.

It could be that months later, HMRC reviews the position and determines that the loan or part of it has effectively been written off. As a result, HMRC treats the amount as taxable income, issuing a personal tax assessment to the director.

At this point:

• The company no longer exists
• The settlement funds are already gone
• The tax bill is personal and enforceable

This is often the moment directors realise that settling a directors’ loan account does not necessarily end the risk. Unless the settlement is done correctly and all circumstances are taken into account, it can raise its head again.

Why This Scenario Causes Problems

This situation arises because two different laws are at play, and they have a different focus:

• Insolvency law focuses on creditor recovery
• Tax law focuses on whether a director has received a taxable benefit

A settlement can therefore easily satisfy one area of law but still trigger issues in the other.

Without proper advice, directors can unknowingly agree to arrangements that solve the insolvency problem but create a tax problem.

This is exactly why cases like Quillan v HMRC, outlined below, matter. They underline that HMRC may still assess tax even where directors believe matters have been finalised.

The Danger of Settlements: Lessons from Quillan v HMRC

The case of Quillan v HMRC is a useful reminder that settling a directors’ loan account does not automatically remove tax risk.

Here is a brief summary of what happened in the case.

Mr Quillan was a director of a UK limited company and had an overdrawn directors’ loan account. He had taken more money out of the company than he had put back in at the point the company became insolvent. A settlement arrangement was entered into in relation to the directors’ loan and this meant that the full amount of the loan was not repaid. From a commercial and insolvency perspective, this resolved the company’s claim against the director.

However, HMRC later reviewed the position and took the view that the way the loan had been dealt with had tax consequences for the director personally.

HMRC argued that:

• The settlement of the directors’ loan account effectively resulted in the loan (or part of it) being released or written off
• When a loan to a director is released, the director has received a financial benefit
• That benefit can therefore be treated as taxable income under UK tax legislation

In other words, even though the company was insolvent and a settlement had been reached, HMRC considered that the director had still obtained something of value.

The Core Legal Issue

The key issue for the court was whether the settlement of the directors’ loan account gave rise to a personal tax liability, despite the insolvency of the company and the commercial resolution of the debt. The core legal question then was whether the Director did indeed benefit financially in a way that should incur tax.

The court, in this instance, agreed with HMRC’s approach.

It found that the settlement meant the director had obtained a ‘taxable benefit’, even though:

• The company was insolvent
• The loan arose during trading
• The settlement was part of closing down the company

As a result, HMRC was entitled to assess personal tax on the director in relation to the settled loan amount.

Why This Case Is Important for Directors

Quillan v HMRC is significant because it confirms that:

• Settling a directors’ loan account does not automatically eliminate tax exposure
• Insolvency outcomes and tax outcomes are not the same thing
• A settlement can resolve the liquidator's claims but still trigger HMRC action

For directors, the case underlines the crucial point that how a directors’ loan account is dealt with matters just as much as the fact that it is has been dealt with.

It should be noted that Quillan v HMRC is subject to an appeal.

Practical Lessons from the Case

The key lesson is not that directors’ loan accounts are wrong in themselves, but that entering into a settlement without understanding the tax implications can be costly.

In broad terms, the case demonstrates that:

• Agreeing to a settlement does not necessarily prevent HMRC from assessing a personal tax charge
• A loan that is written off or compromised can still be treated as taxable income
• The tax treatment depends on how, when, and why the settlement is reached
• Many directors assume that once a settlement is agreed with a liquidator or creditor, the matter is closed.

Unfortunately, that is not always how HMRC sees it.

Some Commonly Misunderstood Areas

To make this clearer, here are some commonly misunderstood terms and why they matter:

Insolvency is when a company cannot pay its debts when due or whose liabilities exceed its assets
A directors’ loan account is a record of money owed between a director and their company
A settlement in this context is an agreement to resolve the debt, often for less than the full amount
A loan write-off, in this context, is when it is agreed that a loan from the business will not be repaid
Personal tax liability is the tax owed by the individual director not the company and therefore not necessarily related to the above, which are primarily about the business

Understanding these terms is essential before agreeing to any repayment or settlement.

Common Misunderstandings Around Directors’ Loan Accounts

Directors often believe that a settlement brings final closure or that HMRC will not pursue tax once the company is insolvent. Many also think that writing off a loan has no personal tax consequences. These are not necessarily true.

In reality, HMRC may still assess income tax where a loan is released or written off, even after insolvency. This can not only lead to unexpected tax bills, but worse than that is that these are likely to come at a time when directors are already under financial pressure.

Why Early Professional Advice Is Essential

The biggest risk is not in having a directors’ loan account as such; they are, in fact, common practice and have a very specific use. Once insolvency is likely, decisions about things such as:

• repayments
• settlements
• loan write-offs

can have long-lasting legal and tax consequences.

At Smart Business Recovery, we work with directors across the UK to assess these risks early and explain the real implications before irreversible decisions are made.

The bottom line is that if your company is experiencing financial difficulty, whether or not you have an active directors’ loan account, understanding your position early could protect you from costly mistakes later.

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