Sarah Bradford explains what to do if you get a letter from HMRC about a director’s loan which has been waived or released.
HMRC has recently written to individuals who, between 6 April 2019 and 5 April 2023, received a director’s loan that has been released or written off and who may not have declared the amount written off as income on their self-assessment tax return. The letter explains what action you might need to take.
Overdrawn ‘directors’ loan accounts’
Directors of personal and family companies may borrow money from the company. They may also owe the company money if the company pays meets personal items of expenditure. Where the company is a close company (as personal companies and most family companies are) there are consequences for the company and if the director’s account remains overdrawn at the corporation tax due date of nine months and one day after the end of the tax year.
Where this is the case, the company must pay ‘section 455 tax’ on the overdrawn loan balance with its corporation tax for the period. The rate of section 455 tax is aligned with the dividend upper rate, and is set at 33.75% for 2025/26.
There may also be a benefit-in-kind tax charge if a loan to a director exceeds £10,000 at any point in the tax year and the loan is either interest-free or interest is payable at a rate which is less than the official rate. The company will also suffer a Class 1A National Insurance contributions (NICs) charge.
At first sight, it may seem a good idea to write off the loan to avoid a section 455 tax charge on the company. If this is done before the corporation tax due date, there will indeed be no section 455 tax to pay. However, writing off a loan has its own tax and NICs consequences, and may not be the best option.
Tax implications of writing off the loan
As far as the director is concerned, if a director’s loan is waived, released or written off, the director is treated as if they had received a distribution equal to the amount written off. The director is taxed at the dividend tax rates – 8.75% where the distribution falls within the basic rate band, 33.75% where it falls within the higher rate band, and 39.35% where it falls in the additional rate band. The director must declare the loan write-off on their self-assessment tax return.
Where the director is also an employee, a tax charge could also arise in respect of the written-off loan under the employment income rules. However, the distribution takes precedence, so the director does not suffer a double tax charge.
From the company’s perspective, as the write-off is treated as a distribution, the amount written off is not deductible in computing the company’s profits chargeable to corporation tax. If the loan was one in which the company had previously paid section 455 tax, that tax will become repayable nine months and one day after the end of the tax period in which the loan was written off. The repayment must be claimed.
NICs implications
There is also a NICs cost for both the director and the company in writing off a director’s loan. Although for income tax purposes, the loan write-off is treated as a distribution, for NICs purposes it is treated as a payment of earnings on which Class 1 NICs are payable by both the director and the company (as the employer).
The rationale for this is that HMRC assumes that the loan is derived from the director’s employment with the company. The First-tier Tribunal confirmed this to be the correct approach in Stewart Fraser Ltd v HMRC [2011] UKFTT 46 (TC). The company should account for the NICs by including the loan write-off in the director’s gross pay for NICs (but not for PAYE) purposes.
It may be possible to argue that the write-off is shareholders’ funds rather than earnings and is not related to the director’s work for the company. If HMRC accepts this to be the case, there will be no NICs to pay. To provide weight to this argument, the write-off should be approved at a general meeting of the shareholders or by a written resolution, and the loan formally waived by a deed of release or similar, confirming the company’s intention to write off the debt. The release should be properly documented in the company’s books. However, it should be noted that HMRC is likely to challenge this interpretation.
Dealing with the letter
Where a letter has been received from HMRC as regards a director’s loan account that was waived, released or written off in 2019/20, 2020/21, 2021/22 or 2022/23 and which has not been declared on the director’s self-assessment tax return, the first step is to establish the facts. For example: has the director had a loan from the company, and if so, when was the loan taken out and for how much? Has the loan been repaid? Was all or part of the loan written off, and if so, when? If only part of the loan was written off, how much? If there was a loan write-off, was it declared to HMRC on the self-assessment tax return? The fact that a letter is received from HMRC does not automatically mean there is something to declare and tax to pay – HMRC does sometimes make mistakes.
If it does transpire that a director has had a loan which has been written off and the loan write-off has not been declared, the action required will depend on when the write-off occurred. If it was during the period covered by the letter (i.e., 2019/20 to 2022/23 inclusive), the director (or their agent) should make a disclosure online using HMRC’s digital disclosure facility (DDS) (see www.gov.uk/guidance/tell-hmrc-about-underpaid-tax-from-previous-years). If the loan was written off prior to 6 April 2016 and not declared, a disclosure can still be made using the DDS.
Following a disclosure, the tax due on the loan write-off will be payable, together with interest and penalties.
If a director’s loan was written off in 2023/24 and not declared on the director’s self-assessment tax return, the position can be corrected by amending the 2023/24 tax return. This must be done no later than 31 January 2026.
If the loan was written off in 2024/25, the director should declare it on their 2024/25 tax return, which must be filed online by 31 January 2026. If the return has already been filed and the loan write-off has not been declared, the return should be amended. The window for doing this runs until 31 January 2027.
Alternatives to writing the loan off
If the company has sufficient retained profits, it would be preferable to pay the director a dividend to clear the outstanding director’s loan rather than to write it off. The director will pay the same amount of income tax on the dividend as on the loan write-off, but there will be no NICs to pay. This can save the director between 2% and 8% of the loan balance and save the company 15% of the loan balance.
If there are insufficient funds to pay a dividend, it may be preferable to pay the section 455 tax if the director pays tax at the higher or additional rate. The section 455 tax will be no more (and may be less) than the tax payable by the director, and there will be no NICs to pay. The section 455 tax will be repaid when the loan is cleared at a later date.
The loan could also be cleared by paying a bonus. However, although a bonus will be deductible for corporation tax purposes, the director will pay tax at the income tax rates. Class 1 NICs (employers and employees) will also be due.
Practical tip
Company directors who have received a letter from HMRC will need to assess whether they need to make a disclosure and settle the tax due on the loan written off. Going forward, consideration should be given to alternatives to writing off a loan, which may be more tax-efficient.
