Tax tribunal clarifies requirements for write-off or release of an overdrawn director loan account for tax purposes

In a recent ruling, the Tax Chamber First Tier Tribunal (FTT) has provided much needed clarity on what constitutes a release or write-off of an overdrawn director’s loan for the purposes of section 415 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). This ruling is particularly significant for directors of close companies who often use loan accounts as a tax-efficient way to remunerate themselves and has implications if the company enters insolvency.

Background

The case in question involved Gary Quillan, the sole director of BOH Investments Limited, which went into voluntary liquidation in January 2017. At the time of liquidation, Mr Quillan’s director’s loan account was overdrawn by £439,954. Despite making partial repayments totalling £57,498, a significant balance of £382,456 remained outstanding. Mr Quillan claimed he did not have the means to repay this amount, and the liquidator’s final report acknowledged that no further funds were expected into the liquidation. The company was dissolved following the conclusion of the liquidation.

Section 415 ITTOIA provides that an income tax charge arises where a company is or was chargeable to tax under section 455 of CTA 2010 (loans to participators in close companies etc.) in respect of a loan or advance, and the company releases or writes off the whole or part of the debt in respect of the loan or advance.

HMRC’s Position

HMRC’s Company Taxation Manual guidance at section CTM61560 - Close companies: loans to participators: Insolvent liquidations and dissolutions, sets out examples highlighting their approach to write-off or release. This generally indicates that where a balance remains unpaid this then amounts to a write off or release and HMRCs view is that the remaining balance is subject to income tax.

HMRC open an enquiry into Mr Quillan’s 2018/19 tax return concluding that since no further recovery action was pursued and the company had been dissolved, the remaining balance should be treated as written off. 

During the course of their enquiry, they obtained information from the former liquidator. This includes statements that “The Director made payments towards the Directors Loan Account as stated in my final report although the matter remained unresolved and was not formally written off.” 

He also stated “Unless a director insists on a compromise, any payments we receive are on account of an Overdrawn Directors Loan Account repayment. As Liquidator, I then report this to creditors to establish whether they wish to fund/acquire the right of action. Failing that, if the case then closes it allows the Company to be restored if I was made aware of any windfall being received by the Director(s).”

Consequently, HMRC issued a closure notice assessing income tax of £145,058 under section 415 ITTOIA, which Mr Quillan appealed.

Tribunal’s Findings

The FTT had to determine whether the second condition of section 415 – the release or write-off of the debt – had been met. 

It was agreed that there is no statutory definition of ‘written-off’ and also that releasing a debt would involve a more formal process than writing it off.

In this case, the parties agreed that a payment of £57,498 was made following an offer made by Mr Quillan to pay £57,500 to settle the liquidator’s claim relating to the overdrawn Director’s Loan Account. This offer was made verbally and no agreement was recorded in writing.

The FTT concluded that a release of a loan requires a formal, conclusive act, such as a deed of release. In this case, such documentation was notably absent. While the liquidators final report says that “no further funds are expected into the Liquidation in this respect” the FTT stated that there was no evidence that any formal release agreement was reached, that the liquidator considered the debt released or that Mr Quillan’s obligations with respect to the Director’s Loan Balance had been released.

As a result, the FTT found that the debt had not been formally released or written off, thus ruling in favour of Mr Quillan.

Implications

This ruling provides some clarity on the interpretation of section 415 ITTOIA, particularly regarding what constitutes a release or write off of an overdrawn director’s loan and highlights the potential tax implications for directors of close companies.

For directors and tax professionals, this ruling serves as a reminder to ensure that any release or write off of director’s loans is properly documented if that is the intention to do so. 

It also emphasises the need for clear communication and documentation between directors and liquidators during a winding-up process. However, and perhaps perversely, it’s perhaps neither in the interests of the liquidator or the director to document a write off or release of an outstanding director loan balance. In not doing so it appears the director won’t be subject to an income tax liability while at the same time it leaves an avenue open for the liquidator to pursue recovery from any future windfalls that the director may have. Perhaps there will be more negotiation leverage between liquidators and directors in agreeing director loan account settlements on this point.