James Bailey warns of HMRC’s approach to dealing with loans to participators such as shareholders.
It is now becoming clear how HM Revenue and Customs (HMRC) are enforcing the new rules relating to repayment of loans to shareholders in close companies introduced in 2013 – and they are taking a hard line.
If a limited company that is a ‘close’ company lends money to a shareholder, the company has to make a payment of tax equivalent to 25% of that loan, which is only repaid after the loan has been repaid. Virtually all family companies are ‘close’ – that is (broadly speaking) they are controlled by five or fewer shareholders, so it is likely these rules apply to your company.
‘Bed and breakfasting’
The rules seek to prevent the practice of ‘bed and breakfasting’ loans, whereby the loan is repaid just before the 25% tax becomes due nine months after the year end, thus avoiding the tax charge, and a new loan is made shortly thereafter.
The rules are particularly strict where the amount of the loan outstanding before the repayment is £15,000 or more. In these cases, the repayment is not counted for the purpose of reducing the 25% tax charge if at the time of the repayment there are ‘arrangements’ for more that £5,000 to be lent in the future.
‘Arrangements’ do not have to be legally binding and there is no time limit. This means that in the case of a typical family company, if there is a further loan of £5,000 or more after the repayment, it will be more or less impossible to show that there were no ‘arrangements’ at the time of the repayment.
Many shareholders in family companies have gotten into the habit of borrowing from the company during the year and repaying just in time to avoid the 25% tax charge, but under the new rules this needs care if it is to be effective.
Exceptions from the ‘arrangements’ rules
The ‘arrangements’ rules do not apply in cases where the repayment ‘gives rise to a charge to income tax on the participator…’ and it is now clear that HMRC are interpreting this rule very strictly.
If the company pays a dividend, or a bonus taxed under PAYE, and this is credited to the loan account in question, HMRC will accept that the ‘charge to income tax’ condition is satisfied, and such repayments are effective to avoid the 25% charge on the company. If, however, the same dividend or bonus is paid into the shareholder’s bank account, it does not meet the test, even if the shareholder immediately uses the money to repay the loan – it was the dividend paid to the bank account that was taxable, say HMRC, not the repayment it was then used for.
A particularly nasty trap involves rent. It is quite common for a family company shareholder to own the business premises outside the company, and for the rent for the property to be credited to his loan account. These rental payments do not meet the ‘taxable’ test and so they cannot prevent the ‘arrangements’ rules from causing them to be ignored for the purposes of the 25% tax charge. The profit from the rental income may be taxable, but a specific monthly rental payment does not itself give rise to a tax charge.
If the company writes off the loan, this too gives rise to a tax charge and is effective, but there are many complications involved in this.
Practical Tip:
Many companies are unwittingly building up potential liabilities to the 25% tax charge (and possibly interest and penalties) as a result of failing to recognise that any repayment of a loan to a shareholder who owes the company £15,000 or more is likely to be ignored, unless it is a dividend or bonus credited directly to the loan account, or the loan is written off.
