In a personal or family company, there are often transactions between the company and the director(s). Perhaps your company pays for a personal expense on your behalf, or maybe you loan money to the business to help with cash flow. It sounds harmless, but when that account becomes overdrawn, it can trigger a domino effect of unexpected tax liabilities.
The most crucial piece of advice regarding director's loans is to avoid treating a loan write-off as an easy exit strategy.
At first sight, writing off the loan may seem a simple solution to avoiding the section 455 tax (the tax you pay on an overdrawn directors’ loan). However, this too has tax consequences.
Where a director’s loan is waived, released, or written off, the director is treated as if they have received a distribution equal to the amount written off. You will be taxed personally on this amount, and your company cannot deduct it from its profits for corporation tax.
If you are steering a growing small to medium-sized business, keeping a close eye on this balance is not just good bookkeeping - it is essential for protecting your cash flow.
Here are the top reasons why staying on top of your director's loan account is vital for your broader financial strategy.
It is important to keep track of transactions between the director and the company. This is done by means of a director’s loan account. If you let the outstanding loan balance exceed £10,000 at any point in the tax year, you may face a personal tax charge under the benefit in kind provisions. On top of this, the company must also pay Class 1A National Insurance contributions at 15% on the taxable amount.
Actively managing the balance using cloud accounting software like Xero or FreeAgent helps you spot when you are approaching this threshold before it becomes a problem. If you’re a Xero user, a top tip is to add your DLA to the chart of accounts watchlist on your dashboard.
Where the director’s loan account is overdrawn there may be tax consequences for the director and the company. Specifically, if the account is overdrawn at the year end and remains so at the corporation tax due date nine months and one day after the year end, the company must pay section 455 tax on the outstanding loan balance.
This is not a small penalty. The rate of section 455 tax is aligned with the dividend upper rate - 35.75% for 2026/27.
If you decide to write off the loan to clear the balance, the director is taxed at the dividend tax rates. This can be highly expensive depending on your personal income bracket.
For example, where the write-off takes place on or after 6 April 2026, the deemed distribution will be taxed at 10.75% where it falls within the basic rate band, at 35.75% where it falls within the higher rate band and at 39.35% where it falls in the additional rate band. You must also declare the loan write-off on your Self-Assessment tax return.
The situation gets more complicated if you also draw a regular salary. Where the director is also a team member within the business, a tax charge could arise in respect of the written off loan under the employment income rules.
Fortunately, the distribution rules take precedence, so the director does not suffer a double tax charge. However, navigating the interaction between employment income and distributions requires careful planning.
Writing off a loan does not just trigger income tax. There is also a National Insurance cost for both the director and the company in writing off a director’s loan. Although for income tax purposes, the loan write-off is treated as a distribution, for National Insurance purposes, it is treated as a payment of earnings on which Class 1 National Insurance contributions are payable by both the director and the company (as the employer).
While it may be possible to argue that the write-off is shareholders’ funds rather than earnings and is not related to the director’s work for the company, this is a complex area to navigate. If HMRC accepts this to be the case, there will be no National Insurance to pay.
From the company’s perspective, as the write-off is treated as a distribution, the amount written off is not deductible in computing the company’s profits chargeable to corporation tax. If you previously paid Section 455 tax on the loan, that tax would become repayable nine months and one day after the end of the tax period in which the loan was written off. Keeping your records straight ensures that this repayment is claimed promptly.
It is important to look at both sides of the coin. If the director is taxed at the dividend upper or additional rates on the deemed distribution, it may be preferable to leave the loan outstanding and pay the section 455 tax. Unlike a loan write-off, there will be no National Insurance to pay. Additionally, if the director is able to pay off the loan at a later date, the section 455 tax will be repaid. The trade-off here is cash flow: leaving the loan outstanding ties up company funds temporarily, whereas writing it off creates a permanent personal tax liability.
Managing a director's loan account effectively is a delicate balancing act. Allowing the account to become heavily overdrawn can lead to severe tax penalties, while writing it off can trigger personal tax and National Insurance liabilities. Using modern cloud accounting tools to track these balances is the smartest way to stay ahead of the curve.
If you are unsure how your director's loan account is impacting your tax position, now is the time to act. Speak to us today to map out a clear, tax-efficient strategy for your business.
If the outstanding loan balance exceeds £10,000 at any point in the tax year, the director may face a tax charge under the benefit in kind provisions.
The company must also pay Class 1A National Insurance contributions at 15% on the taxable amount.
If the account is overdrawn at the year end and remains so at the corporation tax due date nine months and one day after the year end, the company must pay section 455 tax on the outstanding loan balance.
No. From the company’s perspective, as the write-off is treated as a distribution, the amount written off is not deductible in computing the company’s profits chargeable to corporation tax.
Yes. If the loan was one in respect of which the company had previously paid section 455 tax, that tax would become repayable nine months and one day after the end of the tax period in which the loan was written off.
If the director is able to pay off the loan at a later date, the section 455 tax will be repaid.
In either scenario, the repayment must be claimed - it is not automatically refunded.