Alan Pink looks at the situation where loans to director shareholders are repaid; and comes up with some counterintuitive suggestions.
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For more in depth discussion on this important area of business taxation, please see our recently released guide, Directors' Loan Accounts Explained.
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The ‘loans to participators’ tax, sometimes referred to by accountants as ‘Section 455 tax’, is one of the strangest kinds of tax ever invented. In a way, it’s more like a loan to HMRC than a true tax payment.
Where a close company (controlled by five or fewer ‘participators’ and their ‘associates’) makes a loan to a participator (generally speaking, someone who is a shareholder in the company) or associate, there is an obligation on the part of the company to pay a tax charge of 33.75% to HMRC. If and when the participator repays the loan to a company, the ‘tax’ is similarly repaid (after a decent interval) by HMRC.
Timing is everything!
The rate of this tax has gone up twice in recent years: firstly, from 25% to 32.5%, when there was a corresponding rise in the rate of tax on dividends paid by higher rate taxpayers; and more recently (on 6 April 2022) by another 1.25% to be in line with the general addition of this amount to National Insurance contributions and dividend tax rates. Where, as is usually the case, the individual concerned receiving a loan from the company is also a director, there’s also a ‘beneficial loan’ benefit-in-kind charge, effectively being tax on a ‘perk’ of the individual’s employment or office with the company. But this tends to be a far less significant issue in tax planning terms.
The tax charge does not arise unless the loan is outstanding not just at the accounting period end but also nine months after the accounting period end when the tax itself falls due. But if you allow the amount to remain outstanding beyond this date, you effectively get a time lag of a year or more before you can get the section 455 tax back. It’s basically refunded nine months after the end of the period in which the loan was repaid. However, a clever ‘wheeze’ that some people used to get up to on a regular basis has now been stopped.
The ‘anti-bed and breakfasting’ rules
Apparently, what these people were doing was arranging for loans to be repaid shortly before the year end date, and then taken out again shortly after that date. So, technically there was no loan outstanding at the balance sheet date, and no Section 455 tax. HMRC finally decided they’d had enough of this and put what’s now CTA 2010, s 464C.
Basically, what the rules do is match new loans against the repayments where those new loans are made within 30 days. So, you’re treated effectively as if you had not repaid the loan, to the extent that you take out a new loan shortly after. This applies to all loans to participators which are more than £5,000.
Not content with that, there’s also a ‘motive test’ applied where the loans are more than £15,000 and the gap is more than 30 days. If the arrangements formed part of an overall plan, you could find later new loans being matched against your repayments. So it’s obviously very important to watch carefully what the company is doing in the way of making new loans after a repayment on which you’re claiming relief.
‘Deemed’ loans to participators
Then (still looking at CTA 2010), there’s what you might call the ‘Section 459 trap’. What this section says is that what might be called ‘indirect loans’ to participators are also caught by the tax.
A typical example is where company A has a participator (P) and does not loan money directly to participator P but loans to company B instead, which then hands over the money to the individual by way of a loan. If this is all part of a concerted plan, HMRC can charge Section 455 tax as if it had been a direct loan from company A to its shareholder.
This leads to the interesting question of whether moving money around in a group of companies, to a company where there is a credit balance in favour of the individual director-shareholder, could be caught by this anti-avoidance rule in section 459. You quite often find that the same person is a participator in companies A and B (indeed, they may be members of the same group).
Let’s suppose that our director shareholder has an overdrawn loan account with company A but a credit balance with company B. If company B has to borrow from another company in the same group to pay out P’s credit balance (so that he can repay what he owes company A), is this caught by section 459?
Taking a literal reading of the law, it seems the answer has to be ‘yes’. But interestingly, HMRC’s internal manuals for inspectors, on addressing this point, only talk about artificial arrangements where a loan has been rerouted through another company in which the individual is not a participator. That is, it’s aimed at a pretty contrived piece of planning. So it may be (although we obviously cannot guarantee this) that a straightforward rearrangement of balances between companies which are all similarly connected to the individual would not have the full rigour of the rules applied by HMRC.
The ‘first in first out’ rule and how to get round it
With the two recent increases we’ve had in the rate of section 455 tax, it might well be the case that the same individual has notched up a series of loans on which tax has been paid at 25%, and then subsequently further loans at 32.5% or 33.75%. If this individual repays the company, which loan is treated as having been repaid? HMRC’s answer (whether technically unassailable or not) is that you have to treat the earlier loans as having been repaid first. So, you’re liable to get 25% of the loan back (or rather the company is) if you’ve got any loans made at a time when that was the tax rate that applied.
Is there a way of getting around this? Well, HMRC is very keen on insisting (when the boot is on the other foot) that separate nominal accounts in the company’s ledger are separate loans. So, if you have your old loans separately stated on different ledger accounts from the new loans, and specifically apply repayments against the new loan, it’s hard to see that HMRC, with any consistency, could claim that you’re not due back tax at the new rate.
Lateral thinking with overdrawn loan accounts
Finally, a bit of lateral thinking. So far, we’ve been adopting the basic assumption that many accountants adopt without question: that you do not want to have an overdrawn loan account with a close company in this way, and you do not want to pay Section 455 tax.
However, is this necessarily the case if the alternative is taking income from the company (usually by way of dividends as being cheaper than remuneration)?
Example: Company loan for home extension
Georgina needs to take £100,000 out of her company to fund some committed expenditure on an extension to her home. Having phoned her accountant, she draws the money out of the company, initially as a loan of £100,000. Her remuneration from the company and other income use up her basic rate allowance, meaning that if she takes the £100,000 as a dividend, she will be paying 33.75% tax on it. The company, on the other hand, if it keeps the loan as a loan to her rather than realising it as a dividend, would also have a 33.75% charge.
But the big difference is that it’s more tax-efficient for the company to pay the tax, as applies with loans and section 455, than the individual. In fact, Georgina would need to draw out about £151,000 in total to leave her with £100,000 after income tax. If the company simply loans £100,000 to her, though, and leaves that loan outstanding, it costs the company a total of £133,750, including the section 455 tax.
Practical tip
So, leaving it as a loan in the above example is much cheaper and better for the company cashflow.
