Mark McLaughlin points out that allocating repayments to specific loans from a company can be beneficial.
The ‘loans to participators’ provisions (CTA 2010, Pt 10, Ch 3) are relatively well-known among potentially affected taxpayers (e.g. shareholders of family and owner-managed companies). The legislation broadly imposes a tax charge on close companies in respect of loans or advances to participators.
Company tax charge
The applicable tax rate is 32.5% (i.e. the ‘dividend upper rate’; see CTA 2010, s 455(2)) for loans or advances made on or after 6 April 2016. For loans or advances made before that date, the charge is 25%.
As a general rule, this tax charge can be prevented in respect of (for example) an overdrawn director’s loan account to the extent that the ‘loan’ is repaid up to nine months after the end of the company’s accounting period in which it is made (s 455(3)).
It is relatively common for director shareholders of family and owner managed companies to receive more than one loan or advance from the company in the same accounting period. If the company’s accounting period straddles 5 April 2016, it is possible that the company may be liable to tax at different rates on loans or advances made to the same individual.
For example, Widgets Ltd has a twelve-month accounting period ended 30 September 2016. Its director shareholder (Mr Smith) received an advance of £50,000 on 4 January 2016 and another £50,000 advance on 4 July 2016. Both amounts are outstanding at 1 July 2017. On the face of it, the company would be liable to a tax charge at 25% on the first advance of £50,000 in January 2016, and 32.5% on the second in July 2016.
Loan repayments
However, suppose that Mr Smith decided to repay Widgets Ltd £40,000 by crediting a company bonus against one of the advances. Clearly, it would be better for Widgets Ltd if he could allocate the repayment against the later advance of £40,000 (on which the tax rate would otherwise be 32.5%), rather than the earlier advance (taxable at 25%). Is this possible?
There is no tax rule covering such repayments. However, in AJM Mansell Ltd v HMRC [2012] UKFTT 602 (TC)), the First-tier Tribunal noted the following principles, derived from 19th century common law cases:
- Separate debts - Where a debtor makes a payment to a creditor he may appropriate the money as he pleases; however, if the debtor does not make any appropriation, the right of application devolves on the creditor (The Mecca [1897] AC 286).
- Running accounts - A different rule applies when the debtor has a ‘running account’ with the creditor (e.g. a bank account); in that situation, a payment is allocated to the earliest debt (Clayton’s case [1816] 1 Mer 572).
The AJM Mansell Ltd case concerned monthly PAYE and National Insurance contributions (NIC) liabilities. The tribunal in that case found that each month’s liability was a separate debt, so there was no ‘running account’. This meant that the rule in The Mecca applied, so the employer could allocate its PAYE and NIC payments in any way it chose, provided that it did so before the money changes hands.
Director’s loan accounts
However, the question of whether the loans to Mr Smith (in the above example) were separate debts is one of fact (see HMRC’s Company Taxation manual at CTM61565).
Many director shareholders will have a single director’s loan account with the company, into which any loans from the company will normally be paid. HMRC’s guidance on close company loans to participators states (at CTM61600):
‘Where there are a number of loans/advances on a single account, any parties involved (participator and/or company) can specify against which debt they want to set the repayment. Where they do not specify, you should set the repayment against the earliest debt first following the rule in Clayton’s Case…’
Thus, if Mr Smith (see above) had a director’s loan account, he should be able to allocate the £40,000 repayment against the company’s advance on 4 July 2016, to reduce the section 455 tax charge at the 32.5% rate.
Practical Tip:
For the purposes of the above example, anti-avoidance provisions to counter ‘bed and breakfasting’ (in CTA 2010, s 464C) did not apply in Mr Smith’s case. However, those rules generally need to be considered for loans to, and repayments by, participators.
