In this article, Jennifer Adams considers the tax implications should a director be unable to repay the balance on their overdrawn directors loan account and the loan has to be written off.
For more in depth discussion on this important area of business taxation, please see our recently released guide, Directors' Loan Accounts Explained.
Many small and medium-sized companies struggled through the pandemic, with some directors or shareholders finding that they have overdrawn loan accounts which they are unable to repay, even after taking salary and dividends into account.
An individual who is a full-time working director with an interest of more than 5% in the company’s share capital is required to repay this amount before the company’s corporation tax is due, nine months after the year end; otherwise, the company is liable to an additional tax charge of 33.75% of the amount (for 2022/23). The director may also be required to pay additional tax and National Insurance contributions (NICs) under the benefit-in-kind rules (e.g., where the balance owing on the loan exceeds £10,000 at any time during a tax year).
However, it is not only director shareholders who may find themselves subject to the rules; they also apply to unpaid loans made to other ‘participators’ (e.g., loan creditors) or their ‘associates’ (e.g., spouse, parent, grandparent, child, grandchild, brother or sister).
Repayment of the tax will only be possible should the loan be repaid. If there is no reasonable likelihood of the debt being repaid, the company can write off the loan formally. The personal tax position for the individual on the loan write-off will depend on whether they are a participator, officer or employee.
Individual's tax position
Where a loan has been made to a participator (who is not a director) and the company has paid the 33.75% tax charge, if the loan is subsequently written off the participator becomes liable to a personal income tax charge as a distribution. The amount written off is taxed at the director's marginal dividend tax rates (i.e., 8.75% if a basic rate taxpayer; 33.75% for higher rate taxpayers; and 39.35% for additional rate taxpayers).
Where the individual is a participator and a director, for income tax purposes the write-off is treated as a distribution. However, there is no such provision in the NICs legislation. In HMRC's Corporation Tax manual (at CTM61660 'Close companies: loans to participators: release or writing off of loan or advance: Class 1 NIC'), the text states that NICs will be due “if it is remuneration or profit derived from an employment”.
To counter the NICs, it is essential that approval for the write-off be made via shareholder resolution (not directors although in practice they might be the same), at a general meeting; the approval being minuted and documented.
Company charge repaid
Following the loan write-off, repayment of the tax previously paid can be reclaimed. It is important to note that the tax is not corporation tax and cannot be offset against any corporation tax liability. The gross amount of the loan written off is reported on the additional information supplementary pages to the tax return headed "Close company loans and arrangements to confer benefits on participators".
It is recommended that an explanation be included in the 'white space' of the return so that a full declaration can be made.
Practical tip
When a company writes off a loan, the right to receive payment remains and, therefore, is an asset of the company. Should the company become insolvent within six years of the writing off, the liquidator could demand repayment. For the loan to be cancelled, it needs to be formally ‘released’, which needs a deed of execution to be valid. Therefore, the preferable position could be for the loan to be written off so that should the director's finances improve, the company will be able to pursue payment.
