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Directors’ Loans: How to Avoid the National Insurance Trap (Updated June 2026)

  • Writer: Xero Queen
    Xero Queen
  • 4 days ago
  • 3 min read

If your director’s loan account (DLA) is overdrawn and has been for some time, you may be considering writing it off to tidy things up. On the face of it, waiving the loan seems simple—but it can come with an unexpected cost: National Insurance (NI) charges for both you and the company.

So, how can you clear the debt without triggering an NI bill? Let’s break it down.


Business men caught in a net
Business men caught in a net

Understanding Loan Waivers and Tax Treatment

When a company writes off a loan made to an individual, the tax outcome depends on the person’s relationship with the business:

  • Employees or directors (non-shareholders)The waived amount is treated as employment income. This means:

    • Subject to PAYE income tax

    • Liable to Class 1 National Insurance (both employer and employee)

  • Shareholders (non-employees)The waiver is treated as a distribution (dividend) and taxed accordingly.

This distinction makes sense—someone receiving value purely as a shareholder shouldn’t be taxed as if they were an employee.



The Director-Shareholder Dilemma

Complications arise when someone is both a director and a shareholder (often called an “owner-manager” or “participator”).

In these cases, a loan waiver could potentially be treated as either:

  • Employment income → PAYE + NI applies

  • Dividend (distribution) → taxed at dividend rates, no NI





Key Rule

👉 The dividend (distribution) treatment takes precedence over employment income for tax purposes.


What This Means in Practice

If the waiver is treated as a dividend:

  • You’ll pay dividend tax rates:

    • 8.75% (basic rate)

    • 35.75% (higher rate)

    • 39.35% (additional rate)

  • You’ll still benefit from the £500 annual dividend allowance

  • Tax is payable via self-assessment, typically by: 👉 31 January following the end of the tax year(e.g. waiver in 2026/27 → payable by 31 January 2028)


Important points:

  • ❌ No corporation tax deduction for the company

  • ✅ No requirement for distributable reserves (since this is a deemed, not actual, dividend)

Money Trap
Money Trap

The NI Trap: Where Things Go Wrong

Here’s the catch:

⚠️ The rules that favour dividend treatment for tax do NOT automatically apply to National Insurance.


HMRC may argue that the loan write-off is actually earnings tied to your role as a director—meaning:

  • Class 1 NI becomes payable

  • Additional cost for both you and your company




How to Avoid the NI Charge

To minimise risk, you need to demonstrate that the loan was made—and waived—in your capacity as a shareholder, not as a director.


Practical steps:

✅ Use a shareholder resolution (not a board resolution)

  • Approve the waiver formally as a shareholder decision

  • This strengthens the argument that it’s a distribution

✅ Document everything clearly

  • Ensure company records support the dividend treatment

  • Avoid language suggesting remuneration or reward for services

✅ Refer to case law if challenged

  • The case Stewart Fraser Ltd v HMRC supports the position that properly structured waivers can avoid NI charges


A Simpler Alternative: Use a Dividend

If your company has sufficient retained profits, there’s a cleaner option:

👉 Declare a dividend instead of waiving the loan


Why this works:

  • HMRC cannot dispute the nature of a dividend

  • No risk of NI charges

  • Straightforward tax treatment


How to implement:

  • Declare a dividend to yourself (and other shareholders if applicable)

  • Instead of paying cash, credit the dividend to your DLA

✔️ This offsets the overdrawn balance without any physical payment✔️ Keeps the process simple and defensible.


Key Takeaways

  • Loan waivers can trigger unexpected NI charges if not handled correctly

  • Director-shareholders benefit from dividend tax treatment—but NI risk remains

  • Structuring and documentation are critical to avoid HMRC challenges

  • In many cases, declaring a dividend is the safest and simplest solution


Final Thought

Clearing an overdrawn director’s loan account isn’t just an accounting exercise—it’s a tax planning decision. With careful structuring, you can avoid unnecessary NI costs and keep things compliant.

If you’re unsure, it’s always worth reviewing your approach with a tax adviser before making entries in your accounts.


Additional Reading



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