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August 23, 2018

Release of Director's Loan - Earnings or Distribution?

It is generally accepted that the writing-off or release of a director's loan in a close company is taxed as a distribution in the director's hands. However, this treatment will not apply where the loan is written-off or released in satisfaction of a performance-based bonus, as demonstrated in the recent First-Tier Tribunal ("FTT") case of Esprit Logistics Management Ltd and Others v HMRC (2018).

Directors' Loan Accounts ("DLA"): The Basics

It is common practice for a director of a close company to have a current account within the company's books, where amounts they are entitled to from the company are credited and amounts taken out are debited.

Where a director has an outstanding loan with a close company which is not repaid within 9 months of the accounting period, a corporation tax charge of 32.5% of the outstanding loan will be charged on the company under CTA 2010 s.455 (the "s.455 tax").

With this in mind, a company may manage the overdrawn DLA by writing-off or releasing the loan with the company receiving a repayment of any s.455 tax already charged.

The director will be treated as receiving a dividend equal to the amount of the loan written-off or released which is then subject to their marginal rates of income tax on dividends (i.e. 0%/7.5%/32.5%/38.1%).

Even though the loan release or writing-off is treated as a distribution for income tax purposes, it is still treated as earnings from employment for NIC purposes, and will therefore be subject to Class 1 NICs (2%/12.8% for the director and 13.8% for the company).

Espirit Logistics Management Ltd & Others v HMRC

That said, where it can be demonstrated that the release of a loan is in reality the means of providing performance-related bonuses, the distribution will be treated as earnings and therefore the director will be subject to income tax at the normally higher rates for employment income (i.e. 20%/40%/45%).


Espirit and a number of other companies entered into a remuneration planning scheme operated by Tenon Ltd and/or Premier Strategies Ltd whereby the companies would waive outstanding loans in place of bonuses that would otherwise have been paid.

The effect of this is that the payment was taxed as a dividend rather than as employment income, and therefore subject to income tax at lower rates on dividends.

The waiver was recorded in the company's profit and loss accounts under "wages and salaries" and the company claimed a deduction in respect of the sums of the indebtedness released.

The Case

The taxpayers argued that the amounts released were distributions and therefore should be subject to the ordinary income tax rates on dividends.

However, HMRC contended that when viewed realistically and commercially, the arrangements do not involve a "release" of the loan. In reality, the release was a bonus and a reward for the director's services; the waiver was simply the mechanism for the delivery of the bonus.

Furthermore, even where the waiver was a genuine release and treated as a dividend, this would not have been a deductible expense for the company.

The Decision

The FTT took a purposive approach and considered the reality of the arrangements, and ultimately agreed with HMRC.

The purpose of the legislation was to impose a charge where the director had been advanced money that they had not repaid.

The FTT held that the loan was released in satisfaction of the payment of bonuses, i.e. the loan was effectively repaid and therefore wasn't within the definition of a "release".

Therefore the amount repaid was taxable on the directors at the higher rates of income tax on employment income.


Contact us today to discuss your tax requirements.
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