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Mark McLaughlin looks at when a directors’ loan account is treated as being discharged.

Directors’ loan accounts (DLAs) in owner-managed and family companies often become overdrawn. Possible tax consequences include: a tax charge under the ‘loans to participators’ provisions; if the shareholder is a director or employee, a benefit-in-kind charge under the beneficial loan rules; and if the loan account is released or written off, an income tax charge on the shareholder (and a repayment of any tax charge for the company on the loan).

It's all in the timing!

The timing of overdrawn DLA credits, repayments, or any release or writing-off determines (for example) the date of payment or repayment of any ‘loans to participator’ charge for the company; the tax year in which a beneficial loan income tax charge for the director is reduced or ceases; and the tax year in which the DLA repayment, release or writing-off is taxable on the shareholder.

Common DLA credits include salary (or bonus) and company dividends.

(a)   Earnings

Specific tax rules determine when cash earnings are treated as having been received for employment income purposes, and when a payment of income is treated as made for PAYE purposes.

HM Revenue and Customs (HMRC) accepts that crediting an account in the employer’s books represents ‘payment’ for tax purposes (see HMRC’s Employment Income Manual at EIM42270).

(b)   Dividends

If a dividend from the company is credited to an overdrawn DLA, care is needed to ensure that company law requirements are satisfied (e.g., the dividend should be properly voted, paid, and formally documented). For tax purposes, dividends are treated as paid on the date they become due and payable, subject to any contrary provision (CTA 2010, s 1168).

A ‘final’ dividend which is properly declared, and which does not specify a date for payment creates an immediately enforceable debt. An ‘interim’ dividend can be varied or rescinded at any time before payment and may therefore only be regarded as due and payable when actually paid (Potel v CIR (1971) 46 TC 958). HMRC considers that an interim dividend is not paid until a right to draw on the dividend exists, which is generally when the appropriate entries are made in the company’s books (see HMRC's Company Taxation Manual at CTM15205).

DLA written off: Or was it?

Usually, close companies are keen to claim that a DLA has been discharged, to obtain repayment of any tax paid by the company. However, in Plumpton v Revenue and Customs [2024] UKFTT 367 (TC), the director-shareholder of a company (BGH) tried to claim that the DLA had not been written off, as that would have resulted in an income tax liability for him (under ITTOIA 2005, s 415).

The taxpayer had a DLA with BGH. In BGH’s accounts to 31 January 2014, an amount shown as owing to BGH by the taxpayer was recorded as having been written off in the tax year 2013/14. BGH reclaimed from HMRC tax previously paid in respect of the overdrawn DLA. However, the taxpayer’s tax return for 2013/14 made no mention of income received by way of the written-off DLA. HMRC amended the return on the basis that the DLA had been written off. However, the First-tier Tribunal concluded from the evidence that there was no writing-off of his DLA; no relevant documents whatsoever showed the DLA being written off.

Practical tip

The Plumpton case underlines the importance of maintaining accurate and contemporaneous records to support whichever tax position is being taken.