Lee Sharpe looks at the anti-avoidance rules for loans to participators and how HMRC likely regrets taking a case before the general anti-avoidance rule panel.
This article looks at loans to participators, the anti-avoidance rules introduced to try to prevent manipulation of the regime, and a general anti-abuse rule (GAAR) panel opinion published in July 2022 that the taxpayer ‘won’ – the first time this has happened!
Basics of directors’ loan accounts
Readers should be familiar with the basic aspects of directors loan accounts (DLAs) being:
It can mean either a formal loan account or something more informal between the company and the director, where the company will often settle the director’s private liabilities.
We usually assume that the director is also a shareholder in the company (and, as such, a ‘participator’ in the company).
The company is ‘close’, meaning that it is controlled by five or fewer participators (see above) or by any number of director-shareholders.
Tax implications: Benefit-in-kind
A DLA is usually interest-free. Where interest is nil or lower than HMRC broadly deems a commercial rate, there is a taxable benefit-in-kind under ITEPA 2003, Pt 3, Ch 7 (s 173 onwards). The charge is because the director is treated as an employee.
The current official rate of deemed interest taxable benefit is ‘only’ 2% per annum, which is quite modest (but may soon rise if inflation drives up high street lending rates).
The benefit is triggered only if the DLA balance exceeds £10,000 at any point in the tax year; however, once it does exceed the threshold, the loan is chargeable for the whole period for which it was taken out during the tax year, not just the period in which it exceeded the de minimis threshold.
Even though the taxable benefit is considered quite modest, it is an annual tax charge, so it may eventually prove expensive if the loan is substantial and triggers the charge for several years.
Tax implications: Loans to participators
A DLA will trigger a temporary charge to corporation tax on the company if it remains outstanding for too long. This is a charge on the company and is triggered where the loan is made to a participator (broadly, shareholder), and the company is ‘close’. Regardless of the control criteria outlined above, a company that is not resident in the UK is not close.
The ‘section 455’ tax charge will arise if the loan has not been repaid or formally released within nine months (plus a day, strictly) of the end of the company’s chargeable period in which the loan was advanced (or, if previously advanced, a later period in which it was increased). This coincides with the standard date for the company’s settling its corporation tax liability, assuming it is not paying by instalments.
The section 455 charge is reduced to the extent that the original loan has been repaid or formally released within the required ‘nine months’ timeframe. The charge is now 33.75% (for advances from 1 April 2022) and the adjustment to dividend taxation that correlates to the health and social care levy.
Once a section 455 tax charge is payable, HMRC gets to keep the money for at least a year, as any tax repayment (following further part or full repayment, formal release, etc. of the loan itself) is due nine months and a day after the company’s chargeable period in which the loan is (part) repaid, written off, etc., subject to the company making a claim.
If the company does not claim the relief within four years of the end of the company’s chargeable period in which the repayment, release, etc. occurs, the tax may be forfeit (CTA 2010, s 458(3)).
Further anti-avoidance measures
The section 455 charge effectively forces the company to pay a deposit equivalent to the hypothetical income tax a ‘high-earning’ individual shareholder would normally pay, so that the Treasury does not lose out if the company never asks for the money back. The benefit-in-kind tax charge, in turn, addresses any low-interest advantage.
Even though the section 455 charge rules were widely drawn, the legislation did not explicitly address where a director-shareholder repays the loan just before the initial nine-month deadline, avoids the company charge, and then takes out further loans soon afterwards – postponing a section 455 tax charge by a further 12 months (commonly called ‘bed and breakfasting’ the loans). In 2013, HMRC consulted on reforming the regime – which included a proposal to make the temporary tax charge permanent!
While HMRC eventually saw sense, it meanwhile introduced special anti-avoidance provisions to combat such loan ‘bed and breakfasting’ (in FA 2013) in particular, what is now CTA 2010, s 464C.
30-day rule
Where the participator repays at least £5,000 against some or all of the initial loan but then borrows further funds from the company within 30 days of that repayment, the benefit of the repayment is restricted by the later borrowing.
A bit like the CGT share identification rules, the repayment is matched with the following advance rather than the original loan, so more of the original loan remains exposed to the imminent section 455 tax charge.
Arrangements rule
Where the 30-day rule is not in point, and the loan outstanding is at least £15,000 and the individual makes a repayment but at that point there is an intention or arrangement in place to ‘re-borrow’ at least £5,000 – at broadly any future date.
This is much more open-ended and is likely to be pursued where HMRC sees several cycles of repayment-then-further-withdrawals-beyond-30-days.
Taxed income antidote
The anti-avoidance legislation excludes where the repayment by the individual has been subject to income tax – typically, salary or dividend paid to the director-shareholder.
However, HMRC insists that the salary, dividend, etc. must be from the same company that made the loan (see HMRC’s Company Taxation manual at CTM61642).
General anti-abuse rule
HMRC recently took a ‘loans to participators’ case to the GAAR advisory panel, and the panel’s opinion was published on 21 July 2022. The scenario was relatively simple; the director-shareholder took the initial loan from the parent company of a group and then repaid the loan by borrowing on commercial terms from a subsidiary (‘bed-and-sub’, if you will). HMRC considered this to be abusive.
The GAAR panel agreed that the arrangements were to avoid tax but said they did not involve contrived or abnormal steps; the provisions could still bite, albeit at a later date, and no value had permanently escaped a tax charge.
This is the first GAAR hearing HMRC has ‘lost’, and it is no doubt furious.
Conclusion
The benefit-in-kind rules for taxable cheap loans and the section 455 tax charge regime can be complex in the fine detail. The taxable cheap loan charges become notably less cheap as interest rates start to rise. We may also see much closer scrutiny of DLAs when making tax digital for companies eventually rolls out.
The section 455 tax charge can be triggered if loans are taken out intentionally, or even ‘accidentally’, such as when a shareholder receives a dividend that is deemed ultra vires or ‘illegal’ and must be repaid; certainly, HMRC will argue that a tax charge arises until such dividends are repaid by any director-shareholder who, in HMRC’s eyes, should have known better. See the Company Taxation manual at CTM20090 and CTM15205. But, as I have had in the past to explain to an HMRC officer, section 455 tax is chargeable only on loans to individuals, not loans to other companies.
Once HMRC has recovered from the trauma of ‘losing’ at the GAAR panel, it seems very likely we shall see urgent revisions to the loans to participators regime to ‘clarify’ that the legislation actually worked as HMRC said it did, all along – notably, across groups of companies.
