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Directors Loan Account Write-offs

Directors Loan Account Write-offs

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I am going to write of a directors loan account to the value of £12k. There are insufficent profits available to make dividends against this amount and as the company is in the construction industry it's unlikely there will be next year either. I am happy that this amount needs to be treated as dividend income (s415) and I know where to put it on the client's personal tax return. As the client is not a higher rate taxpayer this should not result in any additional tax for the client to pay (salary of £6k plus dividends of £22k plus write of DLA of £12k.

My problem lies with the HMRC guidance relating to CTM 61630 Close Companies: Loans to Participators: Release or Writing off of loan. It states that

1. "where the participator .....is also an employee, there is potentially also a charge under Schedule E rules. Any amount chargeable under s415 is not also charged as income from employment"

2. "Where the participator is an employee, the amount written off will attract Class 1 NIC if it is remuneration or profit derived from employment"

My take on this being that if I am treating the £12k as dividend income then there is no charge to Class 1 NIC. Can anyone tell me if this is right? I have no idea what they mean in point 2!

Many thanks in advance!

Sir Digby

Replies (10)

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By blok
06th Dec 2010 15:46

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·         If the director is a participator in a close company, the loan is treated as a distribution grossed at the dividend tax rate (s415 ITTOIA 2005). Declare it on the Box 13 Additional Information pages on the directors personal tax return; the director is liable to higher rate tax if appropriate. 

·         HMRC’s view is that the write off  is earnings and Class 1 NIC should be accounted for (CWG2 (2010) page 82 and National Insurance Manual 12020); try to argue that write off made to the individual in his or her capacity as shareholder, not as employee.

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By andypartridge
06th Dec 2010 16:37

How?

I would have thought that it would be more difficult to justify that the write-off is in connection with the 'shareholder' when the 'director' has been paid a salary of less than market rate.

I have never quite understood how a loan write-off could be 'tax-free' at basic rate when there is so much fuss about maximum dividend availability and the steps necessary to make a dividend 'legal'.

If there was any justice for those companies who take dividend declaration seriously, then administering Class 1 NIC on those who don't would be it!

-- Kind regards Andy

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Nichola Ross Martin
By Nichola Ross Martin
07th Dec 2010 10:54

Read this guide I prepared

Directors' loan accounts

Hopefully that explains it for you. No CT relief, taxed as a distribution, may well be chargeable to NICs.

I would also be very concerned about making this write off from a Company law perspective and with regard to the insolvency rules. Directors have a fiduciary duty to act in a company's best interests and so I might suggest that you have a rethink about what you are advising - particularly if the company is looking wobbly as trading receipts are down.

Any queries please come and find me: www.rossmartin.co.uk

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John Stokdyk, AccountingWEB head of insight
By John Stokdyk
06th Dec 2010 17:04

Expert guide published on Friday

Hi Sir Digby,

Your query is one of a sequence we've seen on directors' loan accounts in recent weeks. In response to this trend, we asked Jennifer Adams to come up with an expert guide on the subject called Get the details right.

If the answers here haven't quite sorted you out, perhaps the guide will.

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By jonsa
13th Dec 2010 11:15

Dividend or not.

Just one point.  You mention there are insufficient profits to declare a dividend, but want to treat the write off as a dividend.  Not allowed, so the Revenue are likely to win any argument about charging NICs and treating it as employment income.  There could be a dividend now up to the level of profits available, but the balance would have to be treated as employment income.  I agree with Nicola - take care and consider the other aspects first.

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By cfield
13th Dec 2010 12:32

Insufficient profits

You say that there are "insufficient profits" to declare a div, so presumably there are at least some profits you could use. I would be inclined to recommend a dividend for as much as possible (after providing for tax) and then treat the rest as bonus. The client will probably get caught for class 1 NI anyway if he writes off the loan and will also suffer a double whammy as the write-off would not be deductible against CT. The bonus would at least be deductible if the company is still trading. Might even be able to get a tax rebate for carry back of losses if there are no profits this year. 

Have you grossed up the divs to see if the client would incur higher rate tax? Looks as though he is on the cusp. May also need to consider tax and employer NI on a BIK if no interest was paid on the loan. Usually best to debit this to DLA at the prevailing rate (currently 4%) to avoid P11D issues. The interest would be subject to CT but the bonus would more than offset.

Chris

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By abelljms
13th Dec 2010 15:52

que?

surely, by defn., you can only pay a dividend out of profits, so don't b surprised if you get in a mess with hmrc.

And if u think it through, the reason the company has no profits is because the same guy has carried on drawing money out of the company to keep his yacht nice instead of reducing drawings in the tough times?

 

 

 

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By blok
13th Dec 2010 17:59

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the drawings by the director wont affect the profits of the company (uless he has declared large salaries). 

The profitability of the company is what affects the profits.

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By Huw Williams
23rd Dec 2010 14:41

Dividend as much as possible and then declare a bonus

Does this work?

Surely the bonus reduces the profits available for a dividend?

Or do you space it out - dividend now and bonus later

 

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By cfield
23rd Dec 2010 15:53

Bonus but no profit to pay out of

Do the dividend first out of distributable profits and then take a bonus later even if no cash exists to pay it.

Not usually a good idea to claim salary/bonus if there are no profits to pay it out of but sometimes it can be tax efficient if you expect to make trading profits in the future and you have no other earnings to utilise your personal allowance against. Then you can carry forward the tax losses, provided of course you can claim them as deductible trading expenses, which means the company must be trading now in some shape or form.

Best to make sure other income isn't taxed at a higher rate as a result and that you do not incur needless PAYE liabilities. But if writing off a DLR is going to incur tax and NI liabilities anyway, it doesn't really make any difference. The best you can do is time the write-off so it incurs the lowest tax liability, if you can. At least with the bonus you have the possibility of carrying forward a tax loss if the company is trading. With a DLR write-off this option does not exist.

Chris

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