While directors’ loan accounts are permissible loans from a company to its directors, they can become thorny problems during annual tax returns, or in cases of insolvency.
Many directors wish their company’s could simply write off the loans but what are the laws around this?
Writing off or Releasing a Directors Loan
It is possible for a company to formally waive its entitlement to recover a directors loan. Companies generally do this by voting the balance as a dividend or a bonus. Directors will need to declare this on their personal tax returns and should expect to pay a higher tax rate, where appropriate.
Directors’ loans are classed as earnings by HMRC and, as such, NIC may need to be paid.
Where the director is also a shareholder, some accountants may take the approach that the write off has been made in the directors’ capacity as a shareholder, rather than as an employee, to avoid NIC.
The limited company will not receive corporation tax relief on the amount of the loan written off.
However, if your company is struggling financially or insolvent you should take advice before writing off your loan.
Written off Directors Loans in Liquidation
When a company goes into liquidation, the insolvency practitioner handling the case has a responsibility to gain the best possible returns for creditors. As such they will investigate the company’s financial affairs in detail.
Where a directors loan is discovered – even if formally written off during the previous accounting year – the liquidator will likely consider this debt an asset of the company, and hence one which needs to be recovered for the benefit of creditors.
However, most liquidators take a common sense approach to recovery. If you are unable to repay the whole amount they will normally be willing to reach a reasonable settlement. This is because the alternative would be to pursue bankruptcy proceedings against you. Bankruptcy typically results in a smaller return to the company because of the costs associated with it and because other creditors might want a share of any assets. If you are unable to reach a reasonable settlement then a liquidator might bring bankruptcy proceedings against you.