Where a Company goes in to liquidation, the Director has an overdrawn loan and is made bankrupt, will the Director have an Income Tax liability when he emerges from Bankruptcy?
I have a client where the Company has just been placed in to administration by its main creditor. The Director has an overdrawn Director's loan account (DLA) of £1m. He will not be able to repay this and will be made bankrupt as a result. He has no assets.
Despite the fact that there is no prospect that any of the DLA will be repaid, I do not expect the administrator to formally write off the DLA until the company is formally liquidated, which is likely to be long after the Director emerges from bankruptcy.
HMRC Manuals at INS44180 stipulate that
"If any part of a loan from the company to the director is not repaid by the director, it can be assessed on the director personally under Section 421 ICTA 1988 (as if the amount were a net dividend), so long as the liquidator formally writes off that unpaid balance.
In order to tax the unpaid element in this way, the liquidator must make an active decision to either write off the debt, or not to pursue it. It is not sufficient that the liquidator merely takes no further action and the liquidation is closed. Therefore the safest course of action is to ask the liquidator to confirm the outstanding balance has been written off.
Many liquidators are reluctant to do this until the last possible moment, in case the director receives a windfall which enables repayment of the loan. But it can be done at the time the liquidation is formally closed (INS42285). In these circumstances ask the liquidator to take the decision at that meeting and then write to the Department confirming it was done prior to closure. If the company is struck off without any formal decision then the loan cannot be assessed.
Given that the Director is likely to be out of bankruptcy long before the company is liquidated, the DLA debt presumably still exists when he does emerge from bankruptcy, unless the administrator formally writes the debt off. If the loan account is technically written off only at the time of the liquidation (and HMRC seek formal confirmation of this), does it therefore follow that the newly released bankrupt now faces a significant income tax charge on the full original loan value (the one he has just been bankrupt for) under s421?
For tax purposes we would want any tax charge on the loan write off to crystalise before his bankruptcy and the resulting tax debt to be wrapped up in the bankruptcy. It would seem rather harsh otherwise, as he would have to declare bankruptcy again over the tax debt.
Or is there some kind of concession when it comes to bankruptcies?
Has anyone ever come across this in practice? It must be fairly common.
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