‘Loans to participators’: The borrowers

Peter Rayney provides a handy FAQ guide on trips and traps with loans to shareholders of closely-controlled companies. 

1. What is the purpose of CTA 2010, s 455? 

CTA 2010, s 455 is a key anti-avoidance weapon for owner-managed companies. Without it, owner-managers could easily sidestep a tax charge by arranging for their company to lend them funds (as opposed to paying a taxable bonus or dividend). However, CTA 2010, s 455 levies a (refundable) tax charge when a close company makes a loan to a participator (i.e., shareholder or loan creditor) or one of their associates (such as a spouse, parent, grandparent, child, grandchild, brother or sister). 

Since CTA 2010, s 455(2) stipulates that the section 455 tax rate is linked to the dividend upper rate, for loans made in 2021/22 the section 455 tax charge is 32.5% on the amount of the loan or advance. However, the rate increases to 33.75% for loans made after 5 April 2023. This aligns the section 455 tax rate with the 1.25% dividend rate increase in 2022/23 (as part of the Health and Social Care reforms introduced by the government). 

A section 455 liability also arises when a participator incurs a debt to the company, for example, when the shareholder buys a personal asset on credit in the company’s name (CTA 2010, s 455(4)). 

There are a few limited exemptions from the charge in CTA 2010, s 456, but they tend to be of little practical use.  

Loans to owner-managers may also attract a taxable benefit under the beneficial loan rules in ITEPA 2003, s 175. If the loan exceeds the £10,000 de minimis exemption and is interest-free or below the current official rate of 2%, a taxable charge will arise based on the 2% official rate. 

2. Are loans to ‘connected’ partnerships and trusts caught by section 455? 

The legislation clearly states that loans to connected partnerships (including limited liability partnerships (LLPs)) and related trusts are caught by CTA 2010, s 455(1)(c)). 

There is no commercial purpose exemption here. Thus, for example, where a close company makes a long-term financing loan to a connected property development LLP for the purposes of its trade, this would be subject to a section 455 charge. 

Broadly speaking, a partnership would be treated as connected if at least one shareholder of the lending company (or one of their associates; see 1 above) was a partner or member of the relevant partnership or LLP. A trust would be related if either:  

• (at least) one trustee; or  

• a beneficiary of the trust (even where they are a discretionary beneficiary) 

is a shareholder or a shareholder’s associate of the lending company.  

3. When does section 455 tax become payable? 

The section 455 tax liability is based on the loan outstanding at the company’s year end. In most cases, the section 455 tax liability falls due nine months after the end of the accounting period in which the loan is made.  

However, provided the loan or advance is repaid or released within this nine-month window, the section 455 tax is extinguished and no payment is therefore required. Where only part of the loan is repaid or released, the relevant part of the section 455 tax is cancelled.  

In practice, repayment of the loan account often takes place by voting a dividend or paying a bonus within this nine-month period, with the relevant tax being payable on the dividend or bonus. In some cases, it may be desirable to clear the loan account by selling personally-owned assets to the company, but this would require consideration of the relevant tax consequences involved. 

Where the company pays its corporation tax under the quarterly instalment payment regime, any (undischarged) section 455 liability must be factored into its instalment payments. 

4. If the loan remains outstanding beyond the nine-month due date, what happens then? 

If the loan (or part of it) remains outstanding after the nine-month due date, HMRC will seek the section 455 tax and charge interest from the due date until the tax is paid.  

When the loan is subsequently repaid, repayment of the section 455 tax is deferred until nine months after the end of the CTAP in which the loan is repaid or released (CTA 2010, s 458). 

5. Is it possible to avoid section 455 tax by ‘bed and breakfasting’ loans? 

This has always been a dangerous practice, but FA 2013 introduced specific legislation to negate the use of bed and breakfasting techniques to avoid a section 455 charge (see CTA 2010, s 464C(1)(3)).  =

It is not therefore possible for the shareholder to repay their loan before the nine-month due date (see 3 above) and then draw out a fresh new loan from the company shortly afterwards. This technique is nullified by the legislation, which effectively matches the repayment of the original loan with the (subsequent) new loan. This means the original loan is still treated as outstanding and the section 455 tax on this loan remains payable. 

6. Does the repayment of the section 455 tax happen automatically? 

No – unfortunately, the repayment of the section 455 tax is not triggered automatically by HMRC.  

The company must specifically reclaim it from HMRC by completing the online L2P form and sending it by post to HMRC. 

Example: Tax treatment of overdrawn director’s loan account 

Edwin, a shareholder in Ashton Ltd (a close company), overdrew his director’s loan account by £30,500 in November 2021. This amount was still outstanding at the end of the company’s accounting period on 31 December 2021, although it was entirely cleared by the payment of a bonus on 30 June 2022. 

The company’s accounts, corporation tax computations and return form CT600 for the year ended 31 December 2021 were submitted to HMRC in September 2022. 

The company must complete the supplementary page CT600A and submit it with the return. In Part 1, the company must show the loan of £30,500 made to Edwin during the period but would also claim relief from the CTA 2010, s 455 liability (in Part 2) as the loan was repaid by 30 September 2022 (i.e., within nine months of the end of the accounting period). 

Edwin would also be subject to an employment income charge on the benefit of the interest-free loan. The company would also be subject to a Class 1A National Insurance contributions charge on the same amount. 

7. Is it possible for the company to release the obligation to repay the loan? 

It is perfectly possible for the lending company to release the loan, although this would only be legally valid if the release is executed under a formal deed of release or waiver – a board minute or letter would not suffice. 

Where a loan to a shareholder is released, the relevant amount becomes taxable (under ITTOIA 2005, s 415). This is treated as dividend income (under ITA 2007, s 19(1)(d)) and is therefore taxed at distribution rates. Loan waivers are therefore able to benefit from the £2,000 dividend nil-rate band.  

Thus, depending on the level of the shareholder’s other income, the deemed dividend income is taxed as the top slice of their total income in 2022/23 as shown below (ignoring the £2,000 dividend nil rate band and personal allowance). 

If the shareholder is a director or an employee (as is often the case), the ITTOIA 2005, s 415 charge takes priority over any employment income tax charge on the waiver under ITEPA 2003, s 188 (due to the statutory priority rule in ITEPA 2003, s 189 (1)(b)).  

However, HMRC has been seeking to assert that the waived amount (or amounts purported to be waived) should be regarded as earnings under general tax principles. The case Stewart Fraser Ltd v HMRC [2011] UKFTT 46 (TC) illustrates this point. In that case, HMRC successfully argued that the released loan was taxable as earnings (hence also subject to employer and employees’ NICs).  

On the other hand, in giving its evidence in the case, HMRC commented that if the loan waiver had been discussed at an all-shareholders meeting, it would be prepared to accept that the release of the loan was made in the capacity of a shareholder (which would mean it was taxable under ITTOIA 2005, s 415). 

Since the lender will invariably be a close company, the release write-off in the accounts would not be deductible for tax purposes (CTA 2009, s 321A). 

Practical tip 

It is often helpful to specify that overdrawn director’s loan accounts are immediately repayable on demand, or they carry an appropriate interest rate. This avoids various accounting and tax complications under financial reporting standard 102.