Novation of a Director’s Loan | Tax Risks and HMRC Disputes Explained
In a previous article, ‘Company Director Loans,’ we outlined key considerations relating to loans made to company directors, including the obligations imposed by company law.
We also outlined the obligation to account to HMRC in respect of the resultant tax stating ‘…liability to relevant taxes is likely whenever a director receives a loan, whether payable by the company, director or both and will depend on how the loan is settled.’
One way to repay a director’s loan is through novation of the debt. HMRC is very aware that such an arrangement may be used to avoid paying the correct level of tax by a director, arising from the operation of his overdrawn account.
In the recent case of N Powell v HMRC [2025] UKFTT 528 detailed consideration was given by the First-tier Tax Tribunal to the tax position upon the novation of a director’s loan account.
Nazaqat Maqsoom of KANGS explains the nature of a novation and comments upon this reported case.
The Nature of Novation
Novation is the replacement of an existing legal contract with a new contract, to which all parties both consent and have an intent to novate.
Effectively, novation is the rescission of one contract which is replaced by a new contract requiring the same acts to be performed, but by different parties. As is usual in contractual matters, consideration i.e. value, must pass between the parties which, in the case of a novation is normally satisfied by the discharge of the old contract.
A debt that is novated has simply been released, not repaid, which will have tax liability implications where a director is released by one party from an obligation to repay a loan from which he has benefited, but where the obligation becomes one to repay the debt to another party. These are the circumstances relevant in the following reported case.
The Case in Focus | N Powell v HMRC [2025] UKFTT 528
The Novation
Powell was a director of Thermoline Limited (‘Thermoline’) and, prior to 2nd July 2020, he had been its sole shareholder.
As a result of a share for share exchange on 2nd July 2020, Thermoline became a subsidiary of Property Holding SW Limited (‘the holding company’), of which Powell was also a director.
On 31st March 2020, Powell owed Thermoline £309,338 by way of a director’s loan account, which by 31st March 2021 had risen to £512,713.89.
On 16th March 2021, Powell, Thermoline and the holding company entered into a novation, deemed to take effect on 31st December 2020, with the result that Thermoline released Powell from his debt. Powell agreed to pay the amount of the debt to the holding company, which accepted that it owed Thermoline an equivalent sum, which was to be left outstanding on an intercompany loan account.
The rearranged situation, therefore, was that Thermoline having released Powell from his obligations, which were transferred to the holding company, it looked to the holding company for repayment of the amount it was owed.
The Basis for the Tax Dispute
Section 455 Corporation Tax Act 2010
Thermoline, which was a close company, was liable to corporation tax on part of the amount due by virtue of this section which states:
- This section applies to a close company which makes a loan or advances money to a relevant person who is a participator in the company.
- There is due from the company, as if it were an amount of corporation tax chargeable on the company for the accounting period in which the loan or advance is made, an amount equal to such percentage of the amount of the loan or advance as corresponds to the dividend upper rate for the tax year in which the advance or loan is made.
- Tax is due and payable on the day following the end of the period of nine months from the end of the accounting period in which the loan or advance was made.
Following the imposition of a charge under section 455, relief is available when the relevant loan is released or repaid. Thermoline claimed such relief and this was granted by HMRC after the novation.
Section 415 Income Tax (trading and Other Income) Act 2005
This section provides that where a company has been charged to tax under S. 455, above, and the company releases or writes off the whole or part of the loan, that amount is subject to income tax and the debtor is treated as having received a deemed dividend.
In other words, where a director has an overdrawn loan account, in a close company, which is released or written off without payment, then that individual will be personally liable to pay income tax on that amount.
As a result of the novation, HMRC held Powell liable for dividend income on the director’s loans he had received.
The Basis of the Appeal
Powell appealed on the basis that, among other things, the debt had not been released or written off but had been fully satisfied or paid by the holding company given its acceptance of the debt under the intercompany loan agreement and that he did not receive any deemed dividend.
The Court Judgment
In a very detailed Judgment, the court:
- Accepted the contractual analysis that the holding company had provided consideration to Thermoline and that Powell was released from his obligations to that company.
- However, the critical tax question was whether or not Thermoline had recovered the amount due under Powell’s director’s loan account.
- Considering the principle from Collins v Addies [1992] STC 746, distinguished the position where a release followed repayment or satisfaction of a debt from that where a release simply substituted one debtor or creditor for another leaving the debt outstanding.
The court noted that this novation did not result in Thermoline recovering its money but simply created an obligation on the part of the holding company to repay it, which in turn was dependent upon Powell to discharge his debt.
It was also the view of HMRC that the holding company was not capable of discharging the outstanding tax obligations of Powell for which it had assumed responsibility.
The Court refused the Appeal of Powell having:
- rejected his argument that the intercompany loan account constituted repayment or satisfaction of his debt,
- found that substitution of a creditor without extinguishing a debt does not amount to repayment for the purposes of s.415, outlined above,
- found the release involved in the novation was a taxable release under s.415 triggering a taxable deemed dividend.
The outcome for Powell was that in addition to still having responsibility to repay his substantial director’s loan, he was also liable for the income tax charge raised under S.415, above.
How Can We Assist?
HMRC remains alert and rigorous in tackling any attempt to avoid payment of the proper amount of income tax and NIC falling due, by whatever means, including any scheme seeking to disguise the full extent of a taxpayer’s income.
The team at KANGS https://www.kangssolicitors.co.uk/people/ has extensive experience gained from advising and representing clients involved in disputes of every conceivable nature involving HMRC over many years. It is essential to seek immediate, experienced advice as soon as the possibility of any dispute with HMRC arises.
Whether you are currently engaged in a dispute with HMRC or foresee one arising, obtaining expert legal advice at an early stage is essential. Our lawyers provide end-to-end support throughout an HMRC investigation, including representation before the Tax Tribunal.
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