Contractors' Questions: How to duck NI on director's loan?

Contractor’s Question: My software company occasionally arranges for a hefty personal bill of mine to be settled. Typically, the sum gets charged to my director’s loan account, but I understand from my accountant that failure to keep this account in credit could attract National Insurance contributions (NICs). Although the account isn’t currently overdrawn, is my understanding correct? If it is, how can I avoid payments charged to the director’s loan account being liable to NI?

Expert’s Answer:  A risk of having to pay National Insurance on payments charged to a director’s loan account does indeed exist. HM Revenue & Customs applies the contributions where it deems the payment to be an advance on payroll earnings, which would otherwise attract NICs.

As you identify in your question, if your director’s loan account is kept in credit, the payment will not be subject to NICs. This general rule applies because you are drawing on your own funds, which are taxed already.

In the event that your director loan’s account becomes overdrawn owing to a payment, whether the payment is made in anticipation of earnings to be credited in the future determines whether NICs would apply.

But there is no NI to pay on the overdrawn amount where the withdrawal is made in anticipation of an introduction of funds that are not classed as earnings — such as personal income, dividends or matured insurance policies.

Lastly, the mere fact that your director’s loan account is generally kept in credit may be sufficient to avoid the risk of being charged NICs. Still, I recommend you ensure that you can prove that your director’s loan account only ever goes overdrawn to the extent that you can anticipate an introduction of funds to your account. And remember, the taxman will also be interested to see if you paid interest on the loan where your account comes in at more than £5,000 overdrawn.

The expert was Jon Sutcliffe, partner at Kingston Smith LLP, a chartered accountancy firm.