A tax to be paid – Changes to the way HMRC view writing off a director’s loan account during insolvency.Posted: Oct 25, 2022

It isn’t unusual that a director of a company will have an outstanding director’s loan account. If that company then goes into an insolvency process, then the loan becomes an amount outstanding to the business and the insolvency practitioner is required to pursue these. Depending on the circumstances these are sometimes partially written off due to the director's personal circumstances. Under new guidelines from HMRC though, there could be a nasty surprise for the director coming

The problem with Directors loans

One of the areas where we regularly see issues arise during insolvency is in the way the company has handled the use of Director's Loan Accounts. Most Directors are paid a small salary and regular dividends by their business. This is a perfectly legitimate and tax efficient way of doing things, but it is reliant on the company making money (or having reserves) to pay those dividends. When facing financial difficulties dividend payments should be stopped because they are based on the company having made enough profit / reserves to pay them to the Director. The salary element is a very different thing from the dividend because it is a contractual payment, dividends are variable based on the fortunes of the company. If the dividends continue to be paid when they really should not have been, it is fairly common practice to move them to a director’s loan account (DLA). This makes them an outstanding amount owed to the company. In the event of insolvency, this will be considered as part of the process and the Director could, and often will, end up owing their own company money.

Of course, there is a problem with collecting that money because the company the Director works for has just become insolvent and he is unlikely to have the funds to pay the DLA back. At this point, a settlement is usually agreed and any remaining amount is written off.

Whether it is written off and by how much is a decision for the Insolvency Practitioner. They will use their judgement to reach the best resolution based on the director’s personal circumstances. Clearly, this is going to be a common sense decision. If a director has a 50k DLA but lives in a £1m value house with no mortgage then it’s reasonable to expect that loan to be cleared. However, if there are no or very limited assets, then a full and final settlement can be agreed.

What changed recently when it comes to Director's Loan Accounts?

Well, actually nothing fundamentally but the question of what a written off directors’ loan means in terms of the directors’ personal finances has been addressed. So, it is not a change as such, more a tightening of the rules. 

There is a disconnect sometimes between the writing off of a sum for a director’s loan and how and where the funds from that loan ended up. So, let’s say this happens…

• A Director unwittingly continues to take dividends amounting to £10,000 when the company should not have paid them
• These are then added to a director’s loan
• That loan is not repaid in time and the company pays tax on it under section 455
• The company then goes insolvent
• The Director no longer has the funds to pay back the loan
•  The loan is written off as being an uncollectable debt

That is pretty much the end of the story… or rather it was.

In a very real way, the corporation tax situation and the director's personal return were not connected in the past although legally the directors were required to disclose the unpaid director's loan account on the next personal tax return. HMRC has now put in place new guidelines allowing for the investigation of what the director paid on the loan. Assuming our director in the above situation has the whole of the £10,000 loan written off.  The insolvency practitioner is required to report the directors’ loan repayment write off to HMRC. So, we assume this will lead to a tax assessment being raised if they haven’t previously reported this.

Directors with DLAs need to be aware that HMRC will now be looking

The short answer to the question at the end of the last paragraph is that the debt is now seen as income. The director may well lose a debt, but they should pay the tax on that debt as income to on their personal tax return. Previously there was little to connect these two things because they belonged to different processes. The liquidation process for a business noted the debt had been written off. The fact the director was now responsible for a tax bill was not really in the remit of the Insolvency Practitioner and their duty to the insolvency process was done at that point. The tax office, if not informed of the written off debt on the self assessment return, had no connection between the two.

New guidance, however, has opened up a reporting process that links these two things. As mentioned above there has been no change in legislation here just that HMRC is taking a proactive approach. The Insolvency Practitioner now has the option to report that the debt has been written off in a way that identifies tax is due from the recipient of the loan. Note the word ‘option’ there. However, in our experience, it is highly likely that the regulations will expect that these should be reported.

The bottom line here is that where in the past a DLA that was written down often would not impact the tax due from the director (even though it really should have) it will now most likely generate a request from HMRC for the money owed.