Example 1 - Tax-free company loan
Terry is the director of his family company, which is ‘close’ (ie broadly closely-controlled). The company prepares accounts to 30 November each year. He wishes to treat his family to a holiday over the Christmas period, and borrows £8,000 from the company on 5 December 2017.
As long as he repays the loan in full by 1 September 2019 and his borrowings from the company remain below £10,000, he can enjoy the loan interest-free and tax-free for nearly 21 months.
By comparison, had he borrowed the money at an interest rate of 6% for the same period, he would have paid interest of £840 for a 21-month loan.
Loan of more than £10,000
If the company has the funds available, it can still be much cheaper to borrow money from your family or personal company and pay the benefit-in-kind tax charge than to take out a commercial loan.
Where the loan exceeds £10,000 at any point in the tax year, the benefit of the cheap or interest-free loan is taxed. The amount that is charged to tax is found by comparing the interest that would be payable at the official rate with the interest actually paid, if any. For 2015/16 and 2016/17, the official rate of interest is 3%, falling to 2.5% from 6 April 2017.
Example 2 – Company loan of £40,000
Lorraine borrows £40,000 from her family company. The loan is interest-free. The company prepares accounts to 31 March each year. Lorraine takes out the loan on 6 April 2016, and it is outstanding throughout the 2016/17 tax year. Lorraine pays no interest on the loan.
For 2016/17, she must pay a benefit-in-kind charge. The cash equivalent of the benefit is £1,200 (being the loan balance of £40,000 at the official rate of interest of 3%).
Lorraine is a higher rate taxpayer and will pay tax of £480 on the benefit. The company will also suffer a Class 1A charge of £165.60 (£1,200 @ 13.85%).
By contrast, if Lorraine had taken out a £40,000 loan for a year from a commercial lender at a rate of 6%, she would have paid £2,400 in interest. Borrowing from her company and paying the tax on the benefit of the loan saves her £1,920.
As long as Lorraine repays the loan by 1 January 2018, there will be no section 455 tax for the company to pay. She will, however, pay a further benefit-in-kind tax charge to the extent the loan remains outstanding in the 2017/18 tax year.
Where the company declares a dividend and credits it to the account, Lorraine will be taxed at the appropriate dividend rate. Where the loan is cleared by means of a salary or bonus payment, tax under PAYE must be deducted, as must Class 1 National Insurance contributions. The company must comply with the reporting requirements imposed by real-time information.
While clearing the loan will prevent a section 455 liability from arising, this will not always be the best route, as the tax payable on the dividend, salary, or bonus payment may exceed the section 455 tax that would be payable if the loan remained outstanding.
Loan still outstanding at the trigger date
Where the loan remains outstanding nine months and one day after the end of the accounting period in which it was made, the company will need to pay section 455 tax with its corporation tax for the period. The rate of section 455 tax is linked to the higher dividend rate, and is set at 32.5% for loans taken out on or after 6 April 2016.
Section 455 tax is a temporary tax in that it is repaid if the loan is cleared – the repayment can be claimed nine months and one day after the end of the accounting period in which the loan was repaid.
If the loan is outstanding at the end of the accounting period but cleared before the trigger date, it must still be reported to HMRC as part of the company tax return.
Anti-avoidance
Anti-avoidance rules exist which prevent exploitation of the rules by repaying the loan shortly before the trigger date and re-borrowing the money shortly after (`bed and breakfasting’) in a bid to extend the tax-free period.
Practical Tip:
Where a personal or family company has funds available, borrowing from the company can be a cheap source of finance – it is possible to enjoy a loan of up to £10,000 for up to 21 months free of tax without falling foul of the rules.