Writing off an outstanding directors’ loan
Being able to borrow money from your business is one of the perks of being a company director. But many owners/directors will be coming out of the Covid pandemic with overdrawn directors’ loan accounts (DLAs) – and without the capital to easily repay these DLAs.
So, if you’re an owner/director in this predicament, what do you do? We’ve outlined the process for writing off these DLAs, so you can remove this outstanding debt and manage your personal finances in the most tax-efficient way possible.
What happens when a DLA is outstanding and repayments can’t be made? Let’s look at how outstanding directors’ loans can become an issue. To make the required repayments, you need to have the available funds. But over the pandemic, many owners/directors will have seen their company revenues drop, cashflow suffer and their own personal income shrink.
You may have taken out a loan from your company which is outstanding at the end of the company’s financial year. If this loan isn’t repaid during the following nine months, a section 455 charge is levied of 33.75% of the amount borrowed. This is repayable by HM Revenue & Customs (HMRC) nine months after the end of the financial year in which the loan is cleared.
If the loan exceeds £10,000 at any time during the year, there are two potential outcomes. 1) either the interest must be paid to the company by the director, or 2) a taxable benefit equivalent to the unpaid interest will be recorded on your P11D..
Often, the loan will be cleared by declaring dividends. But declaring dividends may not always be possible – or even desirable. There might not be enough retained profits to cover a dividend, or there may be multiple shareholders who don’t want to either take dividends or give waivers.
How does writing off the DLA help? An option is for the company to write-off the loan. If the DLA is written off, this avoids the section 455 charge being levied, or will trigger the recovery process if it’s already become due.
The write-off will be recorded as an expense in the company’s accounts, but won’t be allowable against profits for corporation tax purposes.
From your perspective as a director, the loan amount that’s been waived will be taxed as dividend income for personal tax purposes. HMRC is likely to argue that it’s employment income for National Insurance purposes and may aim to recover both the employee and employer’s National Insurance contributions.
The key here is to demonstrate that the write-off was made in your capacity as a shareholder, rather than it being derived from employment. If you can demonstrate this to HMRC then National Insurance won’t be due.
To bolster that argument, the write-off should be formally approved by the company at a shareholders’ (not directors’) meeting and the reasoning for treating it that way recorded in the minutes. Also, the right to repayment of the loan should be formally released through a legal deed.
Talk to us about the treatment of your directors’ loans It may be either impossible or undesirable to clear overdrawn DLAs by dividends and other regular means. In these situations, it’s sensible to think about writing off the loan. Any write-off needs to be formally approved by your shareholders to avoid National Insurance contributions becoming payable. We can talk you through the process of approving the write-off, recording the decision and ensuring the release of the amount that’s due. If you have overdrawn DLAs that won’t be cleared in the normal course of events, come and talk to us. We’ll help you resolve the situation in the most effective and tax-efficient way.