Waive goodbye! Writing off a director’s loan

Sarah Bradford looks at the tax and National Insurance contributions implications of writing off a director’s loan account. 

In a family or personal company scenario, director’s loans can be very beneficial. Where there is a close relationship between the director and the company, it is easy for the boundaries to become blurred; the director may meet company debts personally and the company may pick up the tab for some of the director’s personal liabilities. A director’s loan account is the mechanism for keeping track of these transactions. 

However, where the company is a ‘close’ company (as family and personal companies generally are), there are implications associated with making a loan to a director, and these need to be taken into account. Broadly, a company is a ‘close’ company if it is under the control of five or fewer shareholders. 

Overdrawn director’s loan account 

A director’s account is overdrawn if the director owes money to the company. Where a loan is made to a director in an accounting period and that loan is not repaid nine months and one day after the year end (which is the date by which corporation tax for the period must be paid), a tax charge (a ‘section 455’ charge) will arise on the company. This is set at 32.5% of the outstanding amount. The rate is the same as the rate at which higher rate taxpayers pay tax on their dividends.  

The section 455 tax is payable with the company’s corporation tax for the period. However, unlike corporation tax, section 455 is a temporary tax which will be repaid once the director has cleared the loan. The repayment of the section 455 tax is made nine months and one day after the end of the accounting period in which the loan was repaid; effect is usually given to the repayment by setting it against the corporation tax due for that period. 

A tax charge may also arise on the director under the benefit-in-kind rules if the loan balance exceeds £10,000 at any point in the tax year – even if only for one day. The amount is taxed under the employment-related loans rules. Where a tax charge arises, the company will also face a Class 1A National Insurance contributions (NICs) bill. 

The section 455 charge is avoided if the loan is repaid or written off before the corporation tax due date (although where it remains outstanding at the year end, it must be reported to HMRC on the company tax return). Where the loan balance is cleared by crediting the director with a salary or a dividend, there will be associated tax, and in the case of a salary or bonus, NIC’s to pay. There are also tax implications associated with writing off a loan. 

Loan write-off: Formal waiver required 

Where a decision is taken to write off a director’s loan, the loan must be formally waived and the waiver legally documented.  

It is not enough for the company simply to decide not to collect the debt; technically, the loan will remain outstanding until such time as it is repaid or legally waived. 

Loan write-off: implications for the director 

The director may not have the funds to repay a director’s loan account, and the company may not have sufficient retained profits to pay a dividend and may not wish to pay a bonus or higher salary. Where this is the case, another alternative is to write off the loan. 

From the director’s perspective, writing off a loan may be the next best thing to receiving a dividend. Rather than being taxed as employment income, the loan written off is treated as a deemed dividend, and the director is taxed on the amount written off at the dividend tax rates. The tax legislation makes specific provision for the deemed dividend treatment.  

Where a tax charge could potentially arise under the dividend rules and the employment income rules, the dividend rules take preference. As the dividend tax rates are lower than the income tax rates, this is a win for the director. The director can also benefit from the dividend allowance where this remains available. 

The director must declare the loan written off on his or her self-assessment tax return. 

However, unlike actual dividends, the deemed dividend that arises when a loan is written off is treated as earnings for Class 1 NICs purposes – resulting in a Class 1 NICs liability for both the director and the company. 

A company can only pay a dividend where it has sufficient retained profits to do so. However, this rule does not apply to the ‘deemed’ dividend arising where a director’s loan is written off. Consequently, the director can effectively benefit from a dividend (but with a NICs charge) where the company lacks sufficient retained profits to declare an actual dividend. 

So, to recap, the tax implications for a director where a director’s loan is written off are as follows: 

• The amount written off is taxed as a deemed dividend at the dividend rates of tax. 
• The amount written off is treated as earnings for Class 1 NICs purposes, giving rise to a liability to employee’s (and employer’s) contributions. 

• The amount of the deemed dividend must be declared in the director’s self-assessment tax return for the tax year in which the loan was written off. 

Loan write-off: tax implications for the company 

Writing off a director’s loan account also has tax and NICs implications for the company. 

As noted above, the amount written off is treated as earnings for Class 1 NICs purposes, with the result that the company will be liable for employer’s Class 1 NICs on the amount written off.  

Dividends are paid out of retained profits and are not deductible in computing the company’s taxable profits for corporation tax purposes. Although there is no need to have sufficient retained profits to cover a loan written off, the write-off is treated as a dividend and is also not deductible in calculating the company’s profits. Thus, unlike a salary or bonus payment, there is no corporation tax deduction in respect of a loan written off. 

On the other side of the coin, where a loan is written off, clearing the loan will trigger a repayment of the associated section 455 tax. The sum will become repayable nine months and one day after the end of the accounting period in which the loan was written off. The amount repayable can be set against the corporation tax liability for that period. 

In summary, the tax and NICs implications for the company of writing off a director’s loan account balance are as follows: 

• The amount written off is not deductible in computing the company’s profits for corporation tax purposes. 
• The amount written off is treated as earnings for Class 1 NICs purposes, giving rise to an employer’s (and employee’s) Class 1 NICs liability. 

• The write-off will trigger a repayment of the associated section 455 tax. 

Example: Formal loan waiver 

Adrian is a director of his family company A Ltd. The company prepares accounts to 31 March each year. In the year to 31 March 2018, Adrian had a loan from the company of £100,000, which remained unpaid on 1 January 2019. The company paid section 455 tax of £32,500. 

As a result of the Covid-19 pandemic, the company does not have sufficient retained profits to declare a dividend for the year to 31 March 2021. A repayment of the section 455 tax would also be beneficial to help the company’s cash flow. 

On 20 March 2021, the company formally waives the loan of £100,000. Adrian has received a salary of £12,500 from the company. He has not used his dividend allowance. 

Adrian is taxed on the dividend at the dividend rates of tax as follows: 

As a director, he has an annual earnings period. He has already received earnings of £12,500 (salary). Further employee contributions of £5,750 ((£37,500 @ 12%) + (£62,500 @ 2%)) are payable. 

The tax and NICs cost to Adrian of writing off the loan of £100,000 is £28,725. 

The company will suffer an employer’s Class 1 NICs liability of £13,800 but will be able to claim a repayment of the £32,500 section 455 tax from 1 January 2022.  

Practical tip 

Despite the associated tax implications for the director and the NICs hit, writing off a director’s loan account should not be discounted – there are upsides as well as downsides.