Mark McLaughlin highlights a case where an overdrawn director’s loan account balance resulted in an unexpected tax charge for a director shareholder.
Director’s loan accounts (DLAs) are a common feature in the financial statements of family and owner-managed companies in particular.
A ‘close’ (i.e., broadly a closely-controlled) company is charged tax (at 33.75%) in certain circumstances where the company makes a loan to a ‘participator’ (e.g., shareholder), commonly in respect of the overdrawn loan account of a director shareholder (CTA 2010, s 455). Where this tax charge arises, relief is generally available to the extent that the loan is subsequently repaid, released or written off.
Now you see it…
However, if the loan is released or written off, the shareholder to whom the loan was made is liable to income tax (under ITTOIA 2005, s 415) at the same rates as dividend income (i.e., 39.35% for 2025/26). It is normally straightforward to establish that an outstanding DLA balance has been released or written off; there would (or at least should) be supporting documentation (e.g., a company board minute).
However, there is a potential pitfall for the unwary. HM Revenue and Customs (HMRC) guidance (in its Savings and Investment Manual at SAIM5200) indicates that an income tax charge can also bite if a debt is transferred (novated) to a third party, resulting in the original debtor being released. HMRC cites case law in support of this proposition (Collins v Addies CA 1992, 65 TC 190).
Expensive deed
A debt novation occurred in Powell v Revenue and Customs [2025] UKFTT 528 (TC). The taxpayer was the director and sole shareholder of a close company (T). On 2 July 2020, following a share-for-share exchange, another company (PHSW) became T’s holding company. The overdrawn balance on the taxpayer’s overdrawn DLA with T gradually increased to £512,713 at 31 December 2020. On 16 March 2021, the taxpayer, T and PHSW entered into a ‘deed of novation’ of the outstanding DLA balance. The deed’s terms included that the taxpayer continued to have a liability in respect of the loan balance to PHSW rather than T. HMRC considered that the taxpayer was liable to an income tax charge (under ITTOIA 2005, s 415) on a deemed dividend payment of £512,713 from T.
Unfortunately for the taxpayer, his appeal was unsuccessful. The First-tier Tribunal (FTT) considered that in financial terms, T had not recovered its money and there remained an outstanding obligation from PHSW of the precise amount from which the taxpayer had been released by T. In that sense, there was a substitution of one debtor for another. Furthermore, the FTT did not consider that PHSW’s liability to T could be said to satisfy the debt owed by the taxpayer. The fact that having sold its interest in the loan to PHSW, T had no right to pursue the taxpayer did not mean that the debt was satisfied. It had been substituted for equivalent value through an alternative debtor. Thus, on both 31 December 2020 and 16 March 2021 the amount of £512,713 remained outstanding. Consequently, T did not recover its money. The FTT found that the taxpayer was released from his indebtedness to T.
Practical tip
The income tax charge in Powell clearly came as an unwelcome surprise to the taxpayer. The tax charge was not declared on his tax return. Expert advice should be sought where consideration is being given to releasing or writing off overdrawn DLA balances.
