Interesting verdict
https://www.accountingweb.co.uk/tax/...irectors-loans
https://www.accountingweb.co.uk/tax/...irectors-loans
The first tier tribunal (FTT) has shed light on what constitutes a release or write-off of an overdrawn director’s loan for the purpose of section 415 Income Tax (Trading and Other Income) Act 2005 (ITTOIA) (s415).
Overdrawn director’s loan accounts are commonly used as a tax-efficient way to remunerate directors of close companies. The release of the debt becomes taxable as a distribution under s415 and is subject to income tax at the dividend rate. What constitutes a write-off or a release for s415 to be invoked is somewhat of a grey area. This FTT judgment offers some much-needed clarity.
Insufficient funds
Gary Quillan, the sole director of BOH Investments Limited, faced a £145,058 income tax assessment from HMRC in relation to an overdrawn director’s loan account following the company’s liquidation in January 2017. At the time of BOH’s voluntary winding-up, the director’s loan account showed an overdrawn balance of £439,954.
Following “protracted correspondence and the threating of legal action” from the liquidator, Quillan verbally agreed to repay a total of £57,500. He then made six payments totalling £57,498 between February and July 2018, leaving an outstanding balance of £382,456, which he claimed he did not have the means to repay.
The liquidator’s final report, issued in March 2019, acknowledged these partial repayments and noted: “No further funds are expected into the liquidation in this respect.”
However, the report did not formally release or write off the remaining debt, and subsequent correspondence from the liquidator confirmed that the matter remained “unresolved.”
BOH was formally dissolved on 15 April 2020.
Released or written off?
Following correspondence with the liquidator, HMRC concluded that because no further recovery action was pursued and the company had been dissolved, the remaining balance should be treated as written off. They issued a closure notice assessing income tax of £145k under s415, which Quillan appealed.
Section 415(1) of ITTOIA provides: “Income tax is charged if (a) 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 (b) the company releases or writes off the whole or part of the debt in respect of the loan or advance.” Both parties agreed that the first condition applied, leaving the FTT to determine whether the second condition – release or write off of the debt – had been met.
It was common ground 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 and the FTT found that the debt had not been released.
On whether the loan had instead been written off Quillan contended that it had not. He cited correspondence from the liquidator to HMRC, which reaffirmed that the loan remained unresolved and that recovery could be pursued in the event of a future windfall for the taxpayer.
HMRC argued that the cessation of collection efforts amounted to a de facto write-off. There is no statutory definition of written off within ITTOIA, but in the closure notice HMRC referred to its own guidance CTM61560 which states: “Any loan balance that is not repaid and is no longer being pursued by the insolvency practitioner is considered to have been written off and that s415, ITTOIA05 should apply to the relevant amount."
They also pointed to the definition of written off in the Cambridge English dictionary: “to accept that an amount of money has been lost or that a debt will not be paid”. HMRC contended that the company had, through its liquidator, implicitly released the debt by accepting a lower settlement albeit verbally and ceasing efforts to pursue the remainder.
The FTT criticised HMRC’s reliance on its internal guidance to justify an income tax assessment, stating: “While we agree that there is no statutory definition of ‘written off’, there is a process available to the liquidator to write off or release the loan of an insolvent company, which the liquidator chose in this case not to follow.
“In our view, in this case, that is the definition of ‘written off’ which should be applied, and an alternative definition should not be substituted for the purposes of the application of s415(1) ITTOIA.”
Door left ajar
Ultimately, the FTT agreed with the taxpayer’s argument that the liquidator had reserved the right to reform the company for the purpose of pursuing Quillan in future, should his financial circumstances improve. This left the door open – however narrowly – to potential enforcement and therefore negated the claim that the debt had been abandoned.
Allowing Quillan’s appeal, the FTT concluded that neither a formal release nor a clear and final write-off had taken place. The fact that the debt was no longer being actively pursued did not meet the threshold required by s415, particularly when the liquidator had made no accounting entry to write off the loan and had retained the right to pursue recovery.
This ruling underscores a disconnect between HMRC’s guidance and actual tax law, which may have broader implications for how overdrawn director’s loan accounts, a common feature of company liquidations, are treated in such scenarios.
Overdrawn director’s loan accounts are commonly used as a tax-efficient way to remunerate directors of close companies. The release of the debt becomes taxable as a distribution under s415 and is subject to income tax at the dividend rate. What constitutes a write-off or a release for s415 to be invoked is somewhat of a grey area. This FTT judgment offers some much-needed clarity.
Insufficient funds
Gary Quillan, the sole director of BOH Investments Limited, faced a £145,058 income tax assessment from HMRC in relation to an overdrawn director’s loan account following the company’s liquidation in January 2017. At the time of BOH’s voluntary winding-up, the director’s loan account showed an overdrawn balance of £439,954.
Following “protracted correspondence and the threating of legal action” from the liquidator, Quillan verbally agreed to repay a total of £57,500. He then made six payments totalling £57,498 between February and July 2018, leaving an outstanding balance of £382,456, which he claimed he did not have the means to repay.
The liquidator’s final report, issued in March 2019, acknowledged these partial repayments and noted: “No further funds are expected into the liquidation in this respect.”
However, the report did not formally release or write off the remaining debt, and subsequent correspondence from the liquidator confirmed that the matter remained “unresolved.”
BOH was formally dissolved on 15 April 2020.
Released or written off?
Following correspondence with the liquidator, HMRC concluded that because no further recovery action was pursued and the company had been dissolved, the remaining balance should be treated as written off. They issued a closure notice assessing income tax of £145k under s415, which Quillan appealed.
Section 415(1) of ITTOIA provides: “Income tax is charged if (a) 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 (b) the company releases or writes off the whole or part of the debt in respect of the loan or advance.” Both parties agreed that the first condition applied, leaving the FTT to determine whether the second condition – release or write off of the debt – had been met.
It was common ground 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 and the FTT found that the debt had not been released.
On whether the loan had instead been written off Quillan contended that it had not. He cited correspondence from the liquidator to HMRC, which reaffirmed that the loan remained unresolved and that recovery could be pursued in the event of a future windfall for the taxpayer.
HMRC argued that the cessation of collection efforts amounted to a de facto write-off. There is no statutory definition of written off within ITTOIA, but in the closure notice HMRC referred to its own guidance CTM61560 which states: “Any loan balance that is not repaid and is no longer being pursued by the insolvency practitioner is considered to have been written off and that s415, ITTOIA05 should apply to the relevant amount."
They also pointed to the definition of written off in the Cambridge English dictionary: “to accept that an amount of money has been lost or that a debt will not be paid”. HMRC contended that the company had, through its liquidator, implicitly released the debt by accepting a lower settlement albeit verbally and ceasing efforts to pursue the remainder.
The FTT criticised HMRC’s reliance on its internal guidance to justify an income tax assessment, stating: “While we agree that there is no statutory definition of ‘written off’, there is a process available to the liquidator to write off or release the loan of an insolvent company, which the liquidator chose in this case not to follow.
“In our view, in this case, that is the definition of ‘written off’ which should be applied, and an alternative definition should not be substituted for the purposes of the application of s415(1) ITTOIA.”
Door left ajar
Ultimately, the FTT agreed with the taxpayer’s argument that the liquidator had reserved the right to reform the company for the purpose of pursuing Quillan in future, should his financial circumstances improve. This left the door open – however narrowly – to potential enforcement and therefore negated the claim that the debt had been abandoned.
Allowing Quillan’s appeal, the FTT concluded that neither a formal release nor a clear and final write-off had taken place. The fact that the debt was no longer being actively pursued did not meet the threshold required by s415, particularly when the liquidator had made no accounting entry to write off the loan and had retained the right to pursue recovery.
This ruling underscores a disconnect between HMRC’s guidance and actual tax law, which may have broader implications for how overdrawn director’s loan accounts, a common feature of company liquidations, are treated in such scenarios.
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