Can I Write Off a Director’s Loan Account?

In short:

Writing off a director’s loan in the normal manner will trigger tax consequences that make it an unattractive option.
Those without sufficient funds to repay a director’s loan can do so via dividends or bonuses paid through the company.
Director’s loans can be written off during the insolvency process should there be no means to pay.

Director’s loans can be a useful financial tool for withdrawing money from your business in lump sums. Left unpaid though, these loans can potentially become a problem further down the line.

In fact, such issues have caught many business owners out when they come to eventually liquidate their companies. As businesses struggle, it can be tempting to borrow more, but if results fail to improve, this account balance can quickly become somewhat of an albatross around its neck.

What issues can a director’s loan create?

Like a normal loan, a director’s loan can accrue interest over time. Unfortunately, for those that leave it unpaid, there can also be a substantial tax bill as a result too.

One of the main issues we see, however, is far more insidious and often tricky to see coming. Tempted by the relatively low price of a cheap liquidation, many fall into the trap of trusting unscrupulous company closure firms to shut down their businesses.

Unfortunately for them, these liquidation services are cheap for a reason, and that’s because they will instead look to take a chunk of any outstanding director’s loans. As they are acting on behalf of the company, they can come after directors for unpaid loans. By doing this, they can offer initial liquidation fees far below the market average, as they will earn much more from the director’s loan account (DLA).

Can a director’s loan account be written off?

Yes. Just like any other loan, if the lender decides to write off the debt, it can be written off. However, this usually comes with a host of tax implications that makes it a poor option.

How do I write off an overdrawn director’s loan?

There’s no authority you’d need to apply to, or any special accounting trick required. A director’s loan account can be written off in the same manner as any other debt.

This doesn’t mean that it’s a recommended course of action, though. Business insolvency expert and Senior Client Manager at Forbes Burton, Ben Westoby, explains that “once a director’s loan has been written off, it is treated as a dividend payment with all of the income tax obligations that they carry. On top of this, HMRC often see it as an employee-related benefit, meaning that there can be National Insurance contributions to pay on it too.

“Given all of the tax that you’d be personally liable to pay, writing a director’s loan off as a business debt is seldom seen as the most economic decision to make.

“Should a business still decide to write off the debt this way, it’s important that it is properly documented. Anything involving director’s loan accounts are likely to attract attention from HMRC who will scrutinise any changes to its status.”

Alternatives to writing off a director’s loan

The best way to resolve a director’s loan will differ from case to case and is dependent on each company’s situation. Here are some of the more effective ways of clearing the debt.

Declaring a standard dividend

If there are no funds readily available to repay the loan, declaring a dividend can be a viable option for many. Of course, this dividend should not be withdrawn from the company, however. By keeping it within the company, it automatically becomes credited to the director’s loan account.

Depending on the amount owed, this can either repay a percentage or the whole loan, but will incur some income tax which will be payable within the same tax year it was declared. The amount of tax due will depend on which bracket you sit within, but directors taking this route will avoid paying NI contributions.

Paying a bonus

Some find that putting money through the payroll as a bonus can help to pay off a director’s loan. As the bonus is net of tax, the company receives a Corporation Tax deduction on the bonus. Be aware though, that directors will still need to pay National Insurance contributions and income tax.

Repaying

Perhaps a boring and obvious answer, but if sufficient funds are available, simply repaying what is owed is by far the most economical solution.

Writing off a director’s loan via insolvency

During the liquidation process, the liquidator may decide that it is impractical or impossible for the director to repay the loan, and waive the company’s claim to the money.

How to avoid paying tax on a director’s loan

There is a nine-month rule on director’s loan accounts. Should the full amount be paid within nine months and one day after the accounting period, then the director should not have to pay any tax.

How much tax is applied to director’s loan accounts?

Should the loan remain unpaid after nine months, the account is classed as overdrawn and HMRC will add an extra 33.7% on top. This is known as Section 455 tax. The idea behind this tax is that it deters business owners from taking out loans each year instead of dividends.

What is the official interest rate for a director’s loan account?

Since the 25/26 tax year a 3.75% interest rate is applied to the loan per annum which is calculated daily.

What happens if you can’t pay back a director’s loan?

The loan simply remains overdrawn and accruing interest. Of course, this is far from ideal, and if the business ever needs to be liquidated, the director can be held personally liable for the amount owed.

How long can a director’s loan be outstanding?

Technically speaking, a director’s loan account can stay outstanding as long as a business continues to operate. However, once HMRC’s taxes begin to accrue on top of the loan amount, you may find that they are alerted to the money owed to them.

HMRC can choose to take a few different options to claim unpaid bill amounts, even starting winding-up petitions against the company in a bid to force it into a mandatory liquidation.

Has your director’s loan become unwieldy?

We’ve helped thousands of businesses to find their way out of financial hurdles. Get in touch with one of our friendly experts to discuss the best route for you and your company to take.

Call us now on 0800 060 8447 for free no-obligation advice. Alternatively, you can get in touch by emailing advice@forbesburton.com.