Lee Sharpe points out some of the tax issues affecting director-shareholders and their companies in respect of loan or current accounts.
The rules which govern loans to shareholders, directors and other employees are complex. Key features and developments are covered here. The reach of these provisions frequently proves longer than many people – including some advisers – appreciate. This article assumes that the reader understands the principles behind taxing ’loans to participators’ and ’beneficial loans’.
Beware the following pitfalls
- Blood is costlier than water – loans to other family members will frequently be caught for both the beneficial loans and the loans to participators rules: shareholders and employees are ‘linked’ to most relatives.
- Loan write-offs – If a company writes off a loan to a participator, then it is treated as a dividend for income tax purposes, in the hands of the participator. This over-rides the general charge to earnings. However, as many readers will be aware thanks to the P A Holdings case(HM Revenue and Customs v PA Holdings Ltd [2011] EWCA Civ 141), distributions for tax purposes may nevertheless be treated as earnings for NICs. While PA Holdings shouldn’t of itself concern many small companies, Stewart Fraser v HMRC [2011] UKFTT 46 (TC) in which (in essence) HMRC successfully argued that the loans were written off because the taxpayer was a director, rather than because he was a shareholder, is much closer to home. The company gets no tax relief for the write-off of a loan to a participator, since the rules were toughened up a few years ago.
- Topping up loan accounts with salary – Where loan accounts become overdrawn (typically because the company pays several of a director’s private expenses) and are then put back into credit by regular salary or a bonus, HMRC may argue that the withdrawals were in fact amounts taken on account of earnings, so PAYE, etc., should have been accounted for earlier, when the amounts were paid out. Thanks to real time information reporting of PAYE (and the penalty regime that comes with it), such small adjustments could prove very expensive.
- Timing of interest payments – An employee may reduce his taxable benefit in kind charge for having a loan at no or low interest, by paying interest to his employer. HMRC frequently challenges interest payments, particularly when they are made after the end of the tax year in question. Interest is allowed to be offset by reference to which tax year the interest is for, not when it is paid. But it can only be claimed after it has actually been paid. Note that HMRC allows a late claim, retrospectively reducing the beneficial loan interest charge, within the normal time limits.
Recent developments
Loans to shareholders etc – ‘section 455 tax’
Several measures were introduced in 2013 to strengthen the regime.
Because the tax (under CTA 2010, s 455) is charged by reference to loans, etc, for the benefit of individuals, many companies have tried to avoid the charge by lending money to companies as intermediaries – such as a company which is in a partnership with the participator(s). HMRC has moved to block any such loans made after 20 March 2013.
It was also common for director-shareholders to put money back into their loan accounts just before the due date to avoid the s 455 tax charge – and then borrow the money back again soon afterwards. HMRC has introduced ‘anti bed-and-breakfasting’ rules, as follows:
- 30 day rule - Where loan repayments totalling at least £5,000 are made to reduce loans subject to the s 455 charge, but within 30 days further loans or advances, also of £5,000 or more, are made in the following accounting period, then the repayments are set against the later loans, and to the extent that those amounts may be netted off, the original s 455 tax charge will therefore continue to stand; and
- ‘Arrangements’ - Where the new ‘30 day rule’ does not act to deny or restrict tax relief, but there are outstanding loans, etc, totalling at least £15,000 and, at the time of a repayment there are nevertheless arrangements to redraw an amount, advance or other conferred benefit of at least £5,000 at any time after that repayment, then the repayment is again matched (so far as possible) against the new chargeable payment instead of reducing the original s 455 tax charge.
In theory, the ’arrangements’ provisions could effectively block s 455 relief indefinitely, if there is an intention ever to make a loan in future.
However, the rules are tempered so that if the repayment is derived from an amount subject to income tax then it is not caught and should secure a refund of s 455 tax as normal. Thus dividends, salary and/or bonus credited against a director-shareholder’s loan account should not trigger the ‘anti bed-and-breakfasting’ rules. They are instead limited to combating revolving finance arrangements, such as where the director-shareholder takes out a short-term loan to put his loan account briefly back in the black, before re-drawing the funds once the s 455 deadline has passed.
Beneficial Loans – Doubling the ‘exempt’ amount
From 6 April 2014, a taxable benefit in kind should only be triggered if the aggregate balance of chargeable loans exceeds £10,000 at any time in the tax year, up from £5,000.
Note that once the limit is breached, however, the loan (or loans) is chargeable in full: it is not just the excess, and not just from the date the threshold is breached.
Practical Tips :
- Loan balances – typically directors’ current accounts – may need to be evaluated on a daily basis, to see if and when the £5,000 (£10,000 from 2014/15) threshold is breached and a benefit in kind is chargeable.
- If loan balances do fluctuate throughout the year, it may well be worth electing for the ‘alternative precise method’, which effectively calculates the taxable benefit on a day-by-day basis, rather than simply looking at opening and closing balances during the year. Note that HMRC can choose to assess on the alternative precise method as well, for instance if he ascertains that the repayment reducing the closing balance happened just before the year-end.
- Get the paperwork right!
- If writing off or waiving a loan, a formal deed of release may be required in order to make the transaction legally enforceable. Otherwise, HMRC may refuse to accept the loan has been waived.
- It is possible to have joint loans, which may be helpful if one party is likely to spend and another to save. HMRC may look for evidence of an intention to create a joint account at the time the loan was taken out, although joint husband and wife accounts are fairly common.
- Directors often authorise interim dividends during the tax year. Where there is no physical payment but a journal entry to the credit of the director-shareholder, (for instance to bring his loan account back into credit), HMRC insists that an interim dividend is not paid until the company’s books have been written up (see their Company Taxation manual at CTM 20095). However, note that in the case of very small companies, directors’ meetings and shareholders’ meetings may essentially be the same thing.
4. It is quite in order to vote a dividend to credit a director’s loan account at the beginning of the tax year, and to draw on it for several weeks or months afterwards. Paying dividends early on should reduce the risk of going overdrawn,incurring a beneficial loan interest income tax charge and s 455 tax on the company.
