Kevin Read explains the different treatment for income tax and National Insurance contributions purposes when an overdrawn directors’ loan account is written off.
It is common for director shareholders of owner-managed business to build up an overdrawn loan account during an accounting period, with a view to subsequently either clearing the loan by a dividend or getting the company to write off (waive) the loan.
Loan write-offs are particularly common if the company cannot pay a dividend to the director that would clear the loan. This could be because there are insufficient distributable profits (which, sadly, may become very common following Covid-19) or, where there are several shareholders who all have the same class of share, paying the dividend would involve paying sizeable dividends to other shareholders too.
‘Deemed’ dividend
For income tax purposes, although such a write-off would be regarded as employment income of the director (under ITEPA 2003) the write-off of a loan to a shareholder in a close company is regarded as a deemed dividend (under ITTOIA 2005, Pt 4, Ch 6). The latter treatment prevails for income tax purposes, with a box to record such write-offs on the additional information pages (SA101) of the self-assessment tax return (box 13.1 for the 2019/20 return).
The usual dividend tax rates apply; but it is only a deemed dividend. There is therefore no requirement for the normal formalities associated with a dividend, including the availability of distributable profits. However, you need to be careful about the National Insurance contributions (NICs) implications, which can often be overlooked.
Dividend waivers and NICs
Those provisions in ITTOIA 2005 apply for income tax purposes, but have no bearing for NICs purposes. In nearly all cases, HMRC will argue that, for Class 1 NICs purposes, the waiving of the loan comes within the definition of ‘emoluments from an office or employment’. HMRC will therefore seek to collect Class 1 NICs from the company, together with interest and penalties where the issue has only come to light as part of an enquiry.
Stewart Fraser Ltd v Revenue & Customs Commissioners [2011] UKFTT 46 (TC) involved an unsuccessful appeal to the First-tier Tribunal (FTT) against HMRC’s assessment of Class 1 NICs on several hundred thousand pounds of loan waivers, covering several years. The appellant claimed that the waivers were made for Mr Fraser in his capacity as the major shareholder in the company, not because he was a director.
The FTT found no evidence to support the company’s contention. The AGM minutes showed that the shareholders had not been consulted; instead, the loan waivers were approved by the directors. The waivers were therefore an emolument of his employment, a decision reinforced by the fact that the loan accounts showed regular deductions to meet expenditure that would usually be paid out of regular remuneration.
Can NICs be prevented?
To have any chance of avoiding Class 1 NICs on loans written off, it is essential to approve the write-off at a general meeting of the shareholders or, where appropriate, to pass a written resolution circulated by the shareholders (not the directors) under CA 2006, ss 292 and s 293.
However, HMRC may still argue successfully that the write-off is really reward for the person’s role as a director, which can only be countered by a successful argument that the write-off is nothing to do with the shareholder’s work for the company.
This could apply (for example) in a family-owned company, where a child who is a director receives a loan from the company to enable them to buy their first home and, several years later, the loan is written off by agreement between the shareholders. This could be argued to be like a normal family loan arrangement, not related to work for the company.
Practical tip
There are many tax issues associated with directors’ loan accounts. HMRC’s ‘Directors’ loan account toolkit’ (at https://tinyurl.com/j69d2fj) will help you avoid errors and penalties.
