Can a company lend money to its directors tax-free?

Alan Pink looks at potential ways of avoiding the usual tax charges when a company lends its directors money.

The attraction of a company lending money to its director rather than paying that director income is obvious.  

If the company lends money, the director is not treated as receiving income and therefore isn’t chargeable to income tax (at rates of possibly 40% or 45%). It’s true the company gets no tax relief for making a loan of this sort, whereas it does get relief for a payment of remuneration (for example); but the company tax rate is currently only 19% and overall it’s clearly to the advantage of the individual (looked at purely as an individual) to receive this money in non-income taxable form.

It’s almost as obvious that, with a potential tax advantage of this order, HMRC is going to arm itself with weaponry to prevent this advantage from being too straightforward and easy to bring about.  

HMRC’s weaponry
Firstly, HMRC can charge income tax (and National Insurance contributions on the company) where a loan is made on favourable terms; that is, where the interest rate charged is less than the ‘official rate’, which is currently 2.5%.  

But the more substantial ordnance comes in the situation where the director concerned is a ‘participator’ (broadly, shareholder or substantial loan stockholder) or an ‘associate’ of a ‘participator’.  Where loans are made to such an individual by a ‘close’ company (i.e. one controlled by five or fewer participators or their ‘associates’), a tax charge arises equal to 32.5% of the amount of loan. This has to be paid over to HMRC and is held by them until such time (if ever) as the loan is repaid or released.  

Avoiding the beneficial loan charge
Firstly, I ought perhaps to point out one way not to do it. Making a loan to someone else, rather than the director personally, won’t take that loan outside the benefit-in-kind charge if the loan is made by reason of the director’s employment (or indeed the employment of any staff member). This means that all kinds of indirect loan arrangements are also caught.  

But the first and most straightforward exception to the tax charge on benefits-in-kind is where the total amount of all loans outstanding in respect of any given person in a year is no more than £10,000.  

In addition to this £10,000 limit, there’s also a £1,000 limit that applies to advances paid to meet future employment expenses.  

Exceptions to the tax charge
Moving from these everyday situations to something a little more obscure, loans are not taxed under these rules where they are made by a company whose business includes money lending. In the case of the benefit-in-kind charge that we are talking about here (but not the ‘loans to participators’ charge discussed below, where there is a similar exception), there is an additional requirement that the company must make at least 50% of its loans to members of the ‘public’.  

So, a loan by Smith Ltd to Mr Smith, its 100% shareholder, will not be outside the benefit-in-kind charge unless the company also lends money commercially to unconnected people. There’s also a fairly stringent requirement, which applies to both sorts of tax I’m talking about in this article, that it should, basically, be a genuine money lending business. I have seen a number of cases in practice where hopeful accountants have advised their clients to set up a ‘business’ of their company lending money in order principally or wholly to take advantage of this exception. But HMRC won’t accept that a company has a business of lending money if in practice it is only lending money to its own people.

‘Qualifying loans’
There’s also a much more useful exception where the loan, if it were an interest-bearing loan, would be eligible for interest relief under the ‘qualifying loans’ rules. The sort of loans that qualify for this potentially very lucrative tax exemption are the following:

•    Loans for the purposes of a trade, profession, vocation or property business;

•    Loans to buy plant and machinery (including such items as cars) where that plant, etc. is going to be used in a trade, etc., an employment or a property business;

•    Loans to acquire shares in, or lend money to, a close company (in the case of loans to the company, the individual must have at least 5% of the company);

•    Investments in cooperatives;

•    Investments in employee-controlled companies;

•    Investments in partnerships;

•    Loans to pay inheritance tax.

Getting out of ‘loans to participators’ charge
The most obvious way of doing this, of course, is not to be a shareholder, loan creditor or ‘associate’ of these! However, leaving aside this obvious exception, there are some others that are less obvious.  

Firstly, if the company supplies the individual concerned with goods, etc. on ordinary credit terms, there is no loans to participators charge provided the credit terms are no longer than those given to the company’s normal customers, and in any event provided the credit period doesn’t exceed six months. In practice, it must be said this exception is very rarely found because the tax charge doesn’t arise in any event unless it is still outstanding nine months after the accounting period in which the loan or credit was first provided.

There’s also an exception for companies carrying on a business of money lending, and I’ve talked about this above in connection with the more restrictive exception from the benefit-in-kind charge.

Where loans of less than £15,000 are made to a full-time director of a company with less than 5% of the company, there is a specific exception available, and this loan will not give rise to a loan to participators tax charge.  

There’s also no tax charge under these provisions (although there would be under the benefit-in-kind rules) where the loan is repaid to the company by a date nine months after its accounting period.  

I’m sorry to say that these rules have been abused in the past. Individuals have borrowed money shortly before the nine-month deadline on a very short-term basis; repaid the loan to the company before the deadline; and then taken out the money from the company again in order to pay off the short-term finance. Anti ‘bed and breakfasting rules have since been introduced to stop you from doing this.  

Finally, the loans to participators tax charge can be avoided by the formal release of the loan by the company. Of course, whilst this makes the loan itself ‘tax-free’, the overall transaction is still within the scope of tax because the release will usually be treated as equivalent to a dividend paid to the individual concerned.  

Nevertheless, it can be useful in some circumstances in deferring an income tax charge from one year to the next, by loaning the amount in year one and releasing it in year two. Generally, also, individuals will be subject to reduced tax on the release as compared with what they would have paid if they had received the amount as remuneration.