Writing off an overdrawn director’s loan account can be tax efficient. The trouble is it can come with a large NI bill. Is there a more tax and NI efficient option?
Director’s loan accounts
You probably already know about the tax that can result if you borrow money from your company. But to recap, you’ll be taxed on 2% of the average balance of the debt, which is a modest charge. There’s no tax if the amount you owed didn’t exceed £10,000 in the tax year. Your company must pay a much higher price; tax equal to 33.75% of what you owed at the end of its financial year which isn’t repaid in the next nine months. This tax charge applies to any amount you owe your company no matter how small.
Avoiding the 33.75% tax charge
As mentioned above, the 33.75% tax bill can be avoided if you repay what you owe your company within the nine months allowed by HMRC’s rules. Naturally, you’ll have to find the money for this. If it comes from your company you’ll have to pay tax and possibly NI contributions first before you can use the net amount to repay the debt. For example, assuming you’re already a higher rate taxpayer (40%) on your salary and you owe your company £10,000, you’ll need around an extra £17,500 gross pay to have enough left to settle what you owe.
Tip. An alternative is for your company to write off the debt. This counts as taxable income for you but is more tax efficient than extra salary.
If you’re a shareholder in your company as well as a director, you’ll pay tax at a lower rate on a loan write-off compared to salary. As a higher rate taxpayer you’ll pay 33.75% (compared to 40%), but your company will need to pay you more money so you pay the tax. Overall it’s still more tax efficient than extra salary. Plus, there’s a cash-flow advantage.
Example. Bob owes his company, Acom Ltd, £20,000 at the end of its financial year which ended on 31 March 2022. To avoid the 33.75% tax charge he draws extra salary in July 2022. The PAYE tax and NI on this is payable by Acom in mid-August 2022. If instead the debt is written off the resulting tax bill for Bob won’t be payable until 31 January 2024.
Trap. A potentially significant drawback to a write-off is NI. HMRC’s view is that “normally” a loan write-off counts as earnings for NI purposes. If an NI bill is factored in a write-off is usually less tax efficient than salary. HMRC’s view is no doubt correct for directors who aren’t shareholders but is questionable if they are. Its argument relies on a write-off being remuneration or profit derived from an employment . Therefore, if you can show that it was because of your position as a shareholder then NI won’t apply. However, proving your view will be tough as HMRC usually plays hard-ball.
Tip. A simpler and absolutely certain way to achieve the same tax efficiency and cash-flow advantage as a write-off is for the company to pay a dividend sufficient to cover the debt.
By: FL Memo