Introduction: A Director's Loan Written Off Is a Tax Event in Two Countries
A director's loan written off by your own UK company feels like the end of a problem, yet for an American owner it is the start of two new ones. In Britain, the release triggers an income tax charge at dividend rates, a likely Class 1 National Insurance bill and no corporation tax deduction. Meanwhile, in the United States, the same release is a distribution of property from a foreign corporation, and how the IRS taxes it depends on what your earlier returns already said about the loan.
Most UK guidance on this subject runs to a few hundred words and stops at the British border. However, the owners we work with at TaxYork are US citizens and green card holders who run consultancies, trading companies, fund management vehicles and family investment companies in London. For them, a director's loan written off has to be read on both returns at once, because the UK and the IRS classify the same entry in the books differently.
What Counts as a Director's Loan Written Off
A director's loan account becomes overdrawn whenever you take more from the company than it owes you in salary, dividends or expense reimbursements. Typically the balance builds up quietly: a house deposit, school fees, a tax bill paid from the company account. A director's loan written off is the moment the company formally gives up its right to be repaid, usually by a board resolution, a deed of release or a liquidator's decision not to pursue the debt.
Importantly, a release is not the same as a repayment. When you repay, nothing new is taxed. When the company releases the debt, by contrast, value passes from the company to you for nothing, and both tax systems want to know what that value is.
Who This Guide Is For
We wrote this guide for American shareholder-directors of UK close companies, dual national US UK founders, and accidental Americans who discovered their US status after years of running a British business. In particular, it suits owners with six- and seven-figure loan balances, those preparing a sale or a members' voluntary liquidation, and anyone who has never filed Form 5471 for the company. If that last point applies to you, the director's loan written off is also a reporting problem, which we cover below.
The UK Charge on a Director's Loan Written Off
The British rules work on three levels: the individual, the company and payroll. Each needs separate attention.
Section 415: Income Tax at Dividend Rates
Where a close company has been chargeable under section 455 on a loan to a participator, and it later releases or writes off the debt, section 415 of the Income Tax (Trading and Other Income) Act 2005 charges the borrower to income tax on the amount released. HMRC's Company Taxation Manual at CTM61655 confirms that the released amount is added to the recipient's total income. Before April 2016 the figure was grossed up for a dividend tax credit; since the tax credit was abolished, the amount released is simply taxed as it stands.
Consequently, a director's loan written off is taxed at the dividend tax rates for 2026/27: 10.75% in the basic rate band, 35.75% in the higher rate band and 39.35% above £125,140. The £500 dividend allowance is available, although at the sums involved it barely registers. Note also that the charge falls on the person who borrowed, so a director's loan written off in favour of a relative who is an associate is taxed on that relative.
Why the Section 415 Charge Takes Priority Over Employment Income
A shareholder-director is usually also an employee, so the write-off could in principle be taxed as employment income under section 188 of ITEPA 2003. However, HMRC's Employment Income Manual at EIM21746 states that an amount treated as income under section 415 is not also charged under section 188. In practice, therefore, the income tax charge on a director's loan written off by a close company is a dividend-rate charge, not a PAYE charge.
The exception arises where the company never paid, and was never liable to pay, section 455 tax on the loan. For example, a loan repaid within nine months of the year end in earlier periods, or one made to a director who holds no shares, falls outside section 415. In those cases the write-off is employment income reported through payroll or on the P11D, and different rates apply.
Class 1 National Insurance: HMRC's Position
National Insurance is where the UK treatment becomes genuinely expensive. HMRC's guidance at CTM61660 says that where the participator is an employee, the amount released is earnings for Class 1 purposes. It relies on Stewart Fraser Ltd v HMRC [2011] UKFTT 46 (TC). As a result, HMRC expects the company to run the director's loan written off through payroll for NIC, even though income tax is collected at dividend rates through Self Assessment.
For 2026/27, the employer National Insurance rate is 15% on earnings above the £5,000 secondary threshold, and an owner-director already paid a salary will have used the threshold. On the employee side, directors above the upper earnings limit pay 2%. Accordingly, a £300,000 release can cost the company £45,000 of employer NIC and the director £6,000 of primary NIC.
Some advisers argue that a release made in the director's capacity as a shareholder is not earnings at all, and that argument has succeeded in negotiation where the board minutes say so clearly. Even so, it is an argument rather than a safe harbour. Furthermore, the capacity in which you received the release matters on the US return too, as we explain later.
The Company: No Deduction, but the Section 455 Refund Returns
On the company side, section 321A of the Corporation Tax Act 2009 denies any loan relationship deduction for a debt released to a participator of a close company. In other words, the company bears the loss without any corporation tax relief.
Nevertheless, there is one benefit. Under section 458 of the Corporation Tax Act 2010, the section 455 tax the company paid on the loan becomes repayable once the debt is released, exactly as if it had been repaid. The refund is due nine months and one day after the end of the accounting period in which the release happens, and the company must claim it. For a large balance, that refund often finances most of the personal tax the director then owes.
Company Law: Distributable Reserves
A release of a debt owed by a shareholder is a distribution under the Companies Act 2006. Therefore, the board needs sufficient distributable reserves at the date of the release, just as it would for a dividend. If the company lacks reserves, the release can be unlawful and the director may remain liable to repay it, which in turn reopens the question of whether anything was ever written off. Before any director's loan written off resolution is signed, the accounts should show that the reserves are there. The ICAEW Tax Faculty's review of the complicated world of loans to participators is a useful summary of how these company law and tax rules overlap.
Quillan and the Liquidation Problem
Many write-offs happen not by resolution but in a liquidation. Here, recent case law has moved firmly in HMRC's favour.
What the Upper Tribunal Decided
In Quillan v HMRC, a director owed his company roughly £382,000 when the company entered liquidation. The liquidator described the balance as irrecoverable in his final account but never formally released it. The First-tier Tribunal held that there had been no write-off, so no section 415 charge arose. However, the Upper Tribunal reversed that decision. In its view, a clear statement by the liquidator that the balance would not be recovered was enough to count as a write-off, even if theoretical recovery remained possible.
Consequently, the director's loan written off charge can arise in the tax year of the liquidator's final report, without any deed or resolution. HMRC's own guidance at CTM61560 says the same: where a liquidator stops trying to collect, HMRC will argue that the loan has been written off, and it encourages liquidators to release irrecoverable balances.
Solvent Liquidations Are Different
In a solvent members' voluntary liquidation, by contrast, the shareholder is entitled to a capital distribution, and HMRC accepts that the distribution can repay the loan by set-off. That route converts what would have been dividend-rate income into a capital gain, and section 458 relief is still due to the company. For owners planning an exit, our guide to members' voluntary liquidation for Americans explains why the US treatment of that capital distribution needs separate planning.
The US Side of a Director's Loan Written Off
Now the analysis changes country. The IRS does not care about section 415 or Class 1 NIC. Instead, it asks three questions: what kind of company is this, what did your earlier returns say about the loan, and in what capacity did you receive the release?
The Release Is a Distribution of Property
Under Treasury Regulation 1.301-1(k), the cancellation of a shareholder's debt by a corporation is treated as a distribution of property. Accordingly, a director's loan written off by a UK company is, for US purposes, a distribution under section 301. It is a dividend to the extent of the company's earnings and profits, then a return of basis, then a capital gain.
For many owners, that dividend is a qualified dividend, because a UK company is eligible for the reduced rate under the US-UK treaty. In that case the federal rate is 20% at the top bracket, plus the 3.8% net investment income tax for most taxpayers. Our guide to the net investment income tax for dual filers explains why UK tax generally cannot reduce that 3.8% charge.
Controlled Foreign Corporations and Section 956
If you own more than 50% of the company, alone or with other US shareholders, it is a controlled foreign corporation. In that case the loan itself may already have been taxed. Under section 956, a loan from a CFC to its US shareholder is an investment in US property, and an individual shareholder must include the average quarterly balance in income, up to the company's untaxed earnings. Our existing guide to the director's loan account and section 956 explains that charge in full.
Here the history matters. If your earlier returns included the loan under section 956, those earnings became previously taxed earnings and profits. Under section 959, a later distribution of previously taxed earnings is not taxed again. Therefore, a director's loan written off after a proper section 956 inclusion often produces little or no new US income, apart from any currency gain on the previously taxed amount.
Conversely, if the loan was never reported, the release is usually a taxable dividend in the year of the write-off. Some commentators argue that a release in an open year should not be taxed where the section 956 year is closed by the statute of limitations. However, that argument only helps someone whose earlier years are actually closed. Where Form 5471 was never filed, section 6501(c)(8) keeps the assessment period open, so the closed-year defence rarely works for owners with missed reporting.
NCTI, the High-Tax Exclusion and Section 962
Since 2018, much of the profit of a UK trading company has either been taxed as GILTI, now renamed net CFC tested income, or excluded under the high-tax election. If you made the high-tax election, the company's earnings stay untaxed in the US until distributed. Consequently, a director's loan written off from those earnings is a dividend when released, and a director's loan written off against previously taxed earnings is largely tax-free in the US. If instead you included tested income each year, perhaps with a section 962 election, the company may hold previously taxed earnings that the release draws out first. Our guide to the section 962 election for US owners of UK companies explains how those layers build up.
Capacity: Dividend or Compensation
The US also asks whether you received the release as a shareholder or as an employee. Typically, where the company is owner-managed and the loan funded personal spending, the IRS will see a shareholder distribution, and the US case law on identifying constructive dividends looks at exactly that question of personal benefit. However, if the board minutes describe the director's loan written off as reward for services, or the company runs it through payroll as HMRC expects for NIC, the US treatment could instead be compensation.
That distinction has real consequences. Compensation for work done in Britain is foreign earned income. It may qualify for the foreign earned income exclusion, which is $132,900 for 2026, and it falls into the general category for the foreign tax credit. A dividend, by contrast, never qualifies for the exclusion. In short, the capacity argument that might save you UK NIC can change the character of the income on your US return, so both positions must be consistent.
Foreign Tax Credits on a Director's Loan Written Off
Here is the good news, relative to the section 455 position. Section 455 is corporation tax paid by the company, so an individual cannot credit it. By contrast, the section 415 charge is income tax levied on you personally, on an amount the IRS also treats as your income. As a result, the UK tax on a director's loan written off is, in principle, a creditable foreign income tax under IRS rules on the foreign tax credit.
Timing and Baskets
The difficulty is matching. If the US taxed the loan years earlier under section 956, the UK tax arrives in a year when the US sees little or no new income. Consequently the credit has nothing to offset in that year and becomes an excess credit, carried back one year or forward ten. Similarly, dividends from a CFC to a 10% US shareholder are looked through to the character of the company's underlying income, so the credit may sit in the general category rather than the passive one. Our guide to foreign tax credit basket errors shows how easily that allocation goes wrong.
National Insurance Is Not Creditable
The Class 1 NIC on a director's loan written off cannot be credited at all. The United States and the United Kingdom have a totalization agreement, and social security taxes covered by such an agreement are not foreign income taxes for credit purposes. Therefore, the £51,000 of combined NIC in our case study below is a pure cost on both sides of the Atlantic.
Case Study: A £300,000 Director's Loan Written Off
Consider an illustrative client. Emily is a US citizen living in London who owns 100% of a profitable consultancy company, so it is a controlled foreign corporation. She draws a salary of £60,000 and has, over several years, built up an overdrawn director's loan account of £300,000 to fund a house purchase.
The UK Numbers
The company paid section 455 tax of £101,250 on the balance at the 33.75% rate that applied to loans made before 6 April 2026. In November 2026, the board resolves to release the full £300,000, having first confirmed sufficient distributable reserves. Because her total income now exceeds £125,140, Emily loses her personal allowance, so her salary fills the basic rate band and £22,300 of the higher rate band.
The director's loan written off then sits on top. After the £500 dividend allowance, £64,640 falls in the remaining higher rate band at 35.75%, which comes to £23,109, and £234,860 is taxed at 39.35%, which comes to £92,417. Her section 415 liability is therefore £115,526, payable on 31 January 2028. In addition, HMRC expects Class 1 NIC: employer NIC of £45,000 and employee NIC of £6,000. The company cannot deduct the £300,000, but it reclaims the £101,250 of section 455 tax on 1 January 2028.
The US Numbers: Two Histories
Emily's US result depends entirely on her filing history. In the first version, she filed Form 5471 every year and her return included a section 956 amount of about $390,000 at an illustrative $1.30 rate. In that case the release in 2026 distributes previously taxed earnings, so there is almost no new US income. However, her £115,526 of UK tax, about $150,000, has little US tax to offset in 2026. Most of it becomes an excess credit, useful only if she has general-category income later.
In the second version, she never filed Form 5471, made no elections and never reported the loan on any US return. Here the release is a $390,000 qualified dividend in 2026. Federal tax at 20% is $78,000, which the UK credit covers. However, the 3.8% net investment income tax adds $14,820 that no UK tax can offset. Moreover, every year without Form 5471 carries a $10,000 penalty exposure and keeps those years open.
What Planning Would Have Changed
Had Emily cleared the balance by declaring a dividend instead, she would have paid the same UK dividend-rate tax but no Class 1 NIC, saving £51,000. Alternatively, a bonus would have been deductible for corporation tax at 25%, saving £75,000 at company level, and on her US return it would have been foreign earned income in the general category. Our guide to salary or dividends for American directors compares those routes in detail. In short, a director's loan written off is usually the most expensive of the three ways to clear a balance.
Alternatives to a Director's Loan Written Off
Because a director's loan written off is so costly, owners should compare the alternatives before the board signs anything.
Clearing the Balance With a Dividend
A dividend voted and set against the loan account clears the balance without any NIC. The UK income tax is the same as under section 415, and the section 455 refund still follows. On the US side, the dividend is a distribution under section 301 in exactly the same way, so the US analysis above does not change. For most American owners, therefore, a properly documented dividend beats a director's loan written off by the full amount of the NIC.
Clearing the Balance With Salary or Bonus
A bonus is taxed through PAYE at up to 45% plus NIC, but the company gets a corporation tax deduction. On the US return, salary for London work is foreign earned income, so it can use the exclusion or the UK credits in the general category, and it carries no net investment income tax. For a director already paying 39.35% on dividends, the combined cost can come out lower, especially where the company pays corporation tax at 25%.
Keeping the Loan Alive
Sometimes the right answer is not to clear the balance at all. A documented loan on commercial terms can stay outstanding, with section 455 tax held by HMRC until repayment. However, the US section 956 charge continues for as long as the loan remains outstanding, so for an American shareholder of a CFC this is rarely cheap. Furthermore, the government's consultation on loans to participators reform could change the UK timing of that charge.
Reporting a Director's Loan Written Off on Both Returns
Getting the paperwork right matters as much as the planning.
UK Reporting
Emily reports the director's loan written off on her Self Assessment return as dividend-type income from a close company under section 415. Meanwhile, the company reports the NIC through RTI, records the release in its accounts and claims section 458 relief on form CT600A. If the release is in a liquidation, the director should confirm with the liquidator exactly when the final report treats the balance as irrecoverable, because Quillan places the charge in that tax year.
US Reporting
On the US side, the release appears on Form 5471 as a distribution, with the previously taxed earnings schedules updated, and on Form 1040 as dividend income or a section 959 exclusion. The UK tax goes on Form 1116. In addition, the company's bank accounts and the loan receivable may affect your FBAR and Form 8938 position; our FBAR and FATCA reporting service handles those filings alongside the return.
Missed Reporting and How to Fix It
Many owners only discover their Form 5471 obligation when a director's loan written off forces the question. If you have missed US tax returns, missed FBAR filings or missed Form 5471 through non-wilful conduct, there are recognised routes to correct the past before the release is reported. Our US tax returns for expats service prepares the catch-up filings and the current-year return as one consistent set.
How TaxYork Can Help
We provide comprehensive tax preparation and compliance for American owners of UK companies. In practice, that means preparing the UK Self Assessment return, the company's section 458 claim and the US return, including Forms 5471 and 1116, as one file, so that a director's loan written off is described the same way to HMRC and the IRS.
Before the Release
Before the board resolves, we model the dividend, bonus and write-off routes against your actual UK and US positions. We check the company's distributable reserves, its previously taxed earnings and your foreign tax credit carryforwards. As a result, you see the combined UK and US cost of each option before anything is signed.
After the Release
If the director's loan written off has already happened, we prepare both years' returns, claim the section 455 refund, and where earlier Forms 5471 are missing, prepare the catch-up filings so the release is reported against a clean history.
Conclusion
A director's loan written off by a UK close company triggers income tax at dividend rates under section 415, a likely Class 1 NIC charge, no corporation tax deduction and a section 455 refund. On the US side, it is a distribution of property whose taxation turns on whether the loan was already included under section 956 and whether Form 5471 was ever filed. The UK income tax is creditable, but the NIC is not, and timing often leaves the credit stranded. For most American owners, therefore, a dividend or a bonus clears the balance more cheaply than a director's loan written off, and the decision should be made with both returns modelled side by side.
Contact Us
If your company is considering a release, or one has already happened, book a consultation with our US-UK specialists. Email hello@taxyork.com or call 020 3488 8606, and we will prepare your UK and US returns as one consistent set.
Disclaimer
This article provides general information about UK and US taxation as understood at the date of publication. It does not constitute tax, legal or financial advice and should not be relied upon for any specific situation. The case study is illustrative, its names and figures are invented, and exchange rates are simplified. Tax law changes frequently, and the treatment of any release depends on your company's records and your own filing history. You should obtain professional advice before acting. TaxYork accepts no liability for actions taken on the basis of this article.
Written by the TaxYork Expert Team — US-UK tax specialists.