A director’s loan – ((GOV.UK “Director’s Loans” )) is money taken from the company accounts that is not salary, dividends, or legitimate expenses.
Many directors withdraw money from their companies because they only take a low salary to reduce their tax bill and also because they find an annual dividend payment to be insufficient. The rules surrounding director’s loans are included in the Companies Act 2006 – ((LEGISLATION “Companies Act 2006” )).
But particularly in these uncertain times, more companies are dealing with hardship and with less government support around, some directors have taken out higher loans and their loan account could be significantly overdrawn. As a result, you may well be questioning if a loan can be written off.
My Business is Struggling – can I Write off a Director’s Loan?
If you enter insolvency, the directors’ loan accounts will be under close scrutiny. It is possible that small sums may be discounted, but overall, a liquidator will look at every avenue to try and secure a return for creditors. Therefore in the majority of cases, the short answer is that if your business is close to or already insolvent, then a director’s loan cannot be written off. Directors may also be pursued to repay the amounts due personally and at worst, you could be made bankrupt.
In a liquidation, the insolvency practitioner also has a duty to investigate your conduct as a director before the insolvency and so you may face disqualification from being a director of any company for up to 15 years.
In challenging situations, it can be easy to forget that a company is a separate entity, but every effort should be made to repay money that is borrowed and to return the director’s loan account to credit.
My Business is Solvent – can I Write off a Director’s Loan?
This is possible, but you should ensure you always take advice as when it comes to directors’ loans, there are many rules and tax implications. Notably, HMRC keeps a close eye on this area and you must ensure there is full disclosure if a loan is written off. To avoid scrutiny you should aim to borrow less than £10,000 if at all possible in any tax year.
It is critical that each director has their own loan account and that they keep accurate records for tax purposes and this information forms part of the company’s annual accounts.
If the director’s loan account is in credit then the loan can be written off and treated as dividends for the next tax submission under the Income Tax Act 2005 – ((LEGISLATION “Income Tax Act 2005” )). It would typically be recorded as a debit in the profit and loss of the services account.
In some circumstances, an overdrawn directors’ loan account can be written off completely. This is in a ‘close company’, defined as being a limited company with fewer than five shareholders. This can allow a director’s loan to be written off if that director is also a shareholder. In that situation, the director’s loan will instead be treated as a distribution of profits.
It may also be possible to reduce the amount by directors voting the balance as a dividend or bonus – though this will not be permissible if the company is going into liquidation. A director’s loan can also be reduced for legitimate reasons, such as mileage or personal expenses used to buy assets for the company.
However, you may also find that HMRC sees a write-off as ‘emoluments from an office or employment and will seek to collect National Insurance Contributions from the company. The director will need to include the amount of the written-off loan in the ‘additional information section of their self-assessment tax return. If you write off a loan, you will not be able to claim any Corporation Tax relief on the amount.
Writing off a loan when a company is solvent may result in a significant tax bill, but this may still be less than being taxed on a salary – so, it would mean paying 32.5% compared to 40%.
When do Directors Need to pay tax on a Director’s Loan?
The tax implications can be significant but much depends on the amount and whether the director’s loan account is overdrawn.
Notably, the loan must be repaid in full within nine months and one day of the company’s year-end. But if this is not possible, then the company will need to pay additional Corporation Tax at 32.5% on the amount. This tax charge applies to any amount you owe your company no matter how small and is under section 455 Corporation Tax Act 2010 – ((LEGISLATION “S455 Corporation Tax Act” )).
It should be possible to reclaim this tax back once the loan is fully repaid but it can be a complicated and time-consuming process.
The director can agree on what interest rate is charged on a loan but if it is below the official rate, then the discount granted to the director may also be treated as a ‘benefit in kind’ by HMRC. This means that the director may be taxed on the difference between the official rate and the rate they currently pay. Class 1 National Insurance (NI) contributions will also be payable on the full value of the loan – the present official rate of interest is 2.5%.
What is’ Bed and Breakfasting’ and a Director’s Loan?
You may have heard of the term ‘Bed and Breakfasting’ which relates to when a director tries to avoid paying tax on their loan.
It occurs when they repay the loan shortly before the year-end which means they avoid tax penalties and then soon after taking out another loan. HMRC sees this as a tactic to avoid tax penalties and as such, when a loan of above £10,000 is repaid by the director, no other loans in excess of this amount can be taken within 30 days. If this occurs, the entire loan will be taxed.
Further, loans that are taken outside of the 30 days may still be taxed, particularly if they are in excess of £15,000:
The rules say that if a director takes a loan that is over £15,000, and before any repayment is made there is an intention by the director to take out a future loan over £5,000 that is not matched to another repayment, the Bed and Breakfast rules will apply.
Given the complexity of these rules and the tax consequences, this is another reason why professional accountancy guidance is essential.
Take Advice on Writing off a Director’s Loan
It can be tempting for directors to make drawings on their company if other routes appear closed, but this can simply be storing up problems for the future and if they can find a way to make a full repayment, this may well be in their best interests. When it comes to liquidation, an overdrawn director’s loan account is often a factor in the company’s failure, in addition to debts owed to creditors such as HMRC.
If you know your company is in trouble, you also should stop taking dividends as this will only be increasing the amount you owe to the business and look at taking a salary via PAYE.
For guidance on the complex issue of directors’ loans, whether these can be written off, and where there are financial problems within a limited company, then a licensed insolvency practitioner is also well placed to provide advice and rescue solutions, in addition to liquidation if this is necessary.