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Back to basics: writing off employee and director’s loans

Our previous back to basics article on loans to employees or directors considered the various tax issues when a loan is provided. If the loan is not repaid, there can be further tax and National Insurance Contribution (NIC) issues when it is written off. These depend on whether the employee or director is a ‘participator’ in the company.

A participator includes a shareholder in the company, but can include a loan creditor of the company or someone with the right to receive income or assets in the company.

Where the loan is provided to an employee or director who is a participator in a close company

The write off will result in the Section 455 tax previously paid on the loan (see our previous article) being refunded to the company. The Section 455 repayment needs to be claimed by the company on the Corporation Tax return for the accounting period in which the loan was written off. It will be refunded by HMRC nine months and one day after the end of that accounting period. This is in a similar way to where a loan is repaid by direct payment or by a salary or dividend.

The employee or director will be subject to an Income Tax charge on the loan being written off and they will need to declare this to HMRC on their Self-Assessment tax return. The loan write off will be taxed at dividend tax rates, where the first £500 is taxed at a rate of tax of 0% and any remaining dividend taxed at 8.75%, 33.75% or 39.35% depending on the taxable income of the employee or director.

In addition to the Income Tax charge, the amount of loan written off will normally be treated as earnings for Class 1 NIC purposes payable by both employee and employer. This must be reported via the payroll, even though the write off is not subject to Income Tax via the payroll. However, it may be possible to mitigate the NIC charge by arguing that the loan was made in the individual’s capacity as a participator rather than an employee or director. Given the complexity, companies considering writing off loans may want to take professional advice to ensure tax costs are minimised.

Where the loan is provided to an employee or director who is not a participator

The position is slightly different where the employee is not a participator, as the Section 455 rules are not relevant and the write off will be treated differently for Income Tax and NIC.

The write off will be treated as earnings, and is subject to Income Tax and both employee and employer Class 1 NIC. The NIC is collected through PAYE, however the Income Tax is not. Instead, the write off should be reported on the employee’s Form P11D in Section M in the box which has no Class 1A NIC payable. The employee is then required to file a Self-Assessment tax return.

If the loan has been written off because the employee or director has died, there is a specific exemption to ensure that no tax charge arises.

Where the loan is provided to a participator in a close company who is not an employee or director

Where the loan is written off the s.455 position is largely the same as that of a participator who is also a director or employee of a company.

The write off is treated as a distribution for Income Tax purposes and the individual will be subject to Income Tax at the dividend rates for the amount written off and they will need to declare this to HMRC on their Self-Assessment tax return. There is no NIC charge as the loan waiver is not earnings, it is treated as a distribution (dividend income).

Corporation Tax treatment

The loan write off will be included as an expense in the company’s accounts. However, where a loan is provided to a participator (irrespective of whether they are an employee or director), the write off will not be an allowable deduction for Corporation Tax and will be added back in the company’s Corporation Tax computation. Where a loan is provided to an employee who is a participator any Class 1 Secondary NIC charged is deductible for Corporation Tax purposes.

Where a loan is provided to an employee who is not a participator, the write off and any Class 1  Secondary NIC is deductible for Corporation Tax purposes.

 

This article reflects the position at the date of publication shown above. If you are reading this at a later date you are advised to check that that position has not changed in the time since.  

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