What are the tax implications if the company decides to write-off a loan?

Despite the various support measures such as Coronavirus Business Interruption Loan Scheme and Bounce Back Loan Scheme, many small companies have struggled to survive through the ongoing pandemic. As a result, some micro-company shareholders/directors may have overdrawn loan accounts with their personal companies which they might not be able to repay. What are the tax implications if the company decides to write-off the loan?

The personal tax position for the individual on the loan write-off will depend on them being a participator (shareholder) and/or officer/employee (director).

Where a loan has been made to a participator (who is not a director) and the close company has suffered the 32.5% corporation tax charge under s455 CTA 2010, there is an income tax charge on the participator if the loan is subsequently written off. The tax charge applies under ITTOIA 2005, s415. Note that this tax treatment only applies where the company has suffered a corporation tax charge. Tax is charged on the amount written off in the tax year (ie arising basis) and for income tax purposes, the balance of the loan written off is treated as a distribution (dividend income) in the hands of the participant. Where the loan was written off on or after 6 April 2016, the taxable amount is the same as the amount written off.

The gross amount of the loan written off is reported in box 13 on page Ai1 of the additional information supplementary pages to the tax return. Practitioners may wish to consider a ‘white space’ disclosure note for additional information purposes.

Under this treatment, there is no national insurance charge as the loan waiver is not earnings.

However, when the individual is a participator and a director, there is potentially a double income tax charge where a loan is written off. The waiver has the potential to be taxed as a distribution to a participator (as above) and also as earnings to a director under ITEPA 2003, s188. Fortunately, to prevent the same income being taxed twice, there is a provision in the legislation (ITEPA 2003, s189) that gives priority to the distribution treatment as above.

There is no similar provision in the national insurance legislation, leading to a potential mismatch between the income tax treatment and the national insurance treatment. The absence of an exemption from a national insurance charge may mean that the income is taxable as a distribution (dividend income) but Class 1 national insurance (both employer’s and employee’s contributions) is collected via the payroll, in accordance with the section for ‘Type of payment: Loans written off’ in booklet CWG2. This is achieved by adding the amount to insurable pay, but not taxable pay, in the payroll.

There is a potential let-out for NIC purposes following the Stewart Fraser Ltd v HMRC (2011) UKFTT 46 (TC) case – it may be possible to avoid a Class 1 national insurance charge by arguing that the loan is made in the capacity of a participator rather than a director. For example, by ensuring that the waiver / write-off of loans is agreed at shareholders’ meetings and properly documented as such. It would also be helpful if the initial advance of the loan had been agreed and documented at an earlier shareholders’ meeting.

HMRC has challenged loan waivers on loans to directors in the past on the basis that the amount of the loan waived constituted earnings on basic principles under ITEPA 2003, s62 and this point was taken in the Stewart Fraser case mentioned above. In brief, the taxpayer contended that the write-off of a loan from the company in which he was a participator was made in his capacity as a shareholder rather than as a director. HMRC successfully argued that the write-off was in fact earnings. This was primarily on the basis that there was no evidence of discussion and approval for the loan waiver at a shareholders’ meeting, which they would have expected had the loan waiver been made in the taxpayer’s capacity as a shareholder. Therefore, it is advisable for loan waivers / write-offs to be discussed and approved by shareholders at a general meeting. The loan must also be waived formally and this should be documented by legal deed.

Repayment of the s455 corporation tax previously paid on the overdrawn loan can be reclaimed under s458 following the loan write-off. Provided online filing validations are not breached (eg repayment due is more than the CT charge for the year, thereby creating a negative tax charge) it should be possible to reclaim this via the CT600A in the year that the loan is written off. Alternatively , the form L2P can also be used to make the reclaim.

This article has been shared from ACCA In Practice, to whom copyright belongs.  Whitefield Tax are an ACCA Member Firm