Iain Rankin explains why it is important to tread carefully when borrowing money from a closely-controlled company.
The majority of UK businesses are close companies, owned by director-shareholders. A close company is a company owned and controlled by five or fewer individual participators or controlled by any number of participators who are also directors.
A participator is broadly somebody who has a share or interest in the capital or income of a company such as having share capital, voting rights or a right to capital on winding up of the company. This can be a shareholder, director or a loan creditor.
HMRC and close companies
Rules relating to loans from close companies are designed to prevent participators from enjoying tax-free funds disguised as loans from the company.
HMRC’s Company Taxation manual at CTM60055 notes: ‘A company controlled by a small group of persons may arrange its affairs to enable those persons to avoid income tax.’ As a result, it has consistently sought to introduce legislation to counter such tax advantages.
Loans to participators
As a director, you are entitled to take a salary from your limited company. As a shareholder, you are entitled to extract dividends from it.
If withdrawals from a company are not treated as salary or dividends they are normally considered a loan. There are special rules on loans made by close companies to ‘participators’ (i.e. broadly, shareholders).
Implications for the company
If a company makes any loan, or advances any money to an individual who is a participator in the company or is an associate of a participator, the company must pay tax at a rate of 32.5% on the amount of the loan or advance.
The tax is charged on the lower of the amount outstanding at the end of the chargeable accounting period or the normal due date under self-assessment, usually nine months after the accounting period ends.
Generally, the tax treatment of debits and credits from company ‘loan relationships’ follows standard UK GAAP treatment. However, in certain situations, if interest is not paid within 12 months of the end of the accounting period, a debit for that interest will not be allowed until it has been paid. These rules are known as the ‘late interest’ provisions, and can be complex.
Implications for the participator
If a loan either remains outstanding or is repaid, there are no further tax implications for the participator. However, if a company chooses to write off the amount of the loan or advance it will receive a repayment of the tax previously paid.
In this case, the individual has received a payment from the company. The participator is normally assessed as having received a dividend equal to the amount of the amount waived. This income will then be taxed via self-assessment.
The date of the loan waiver is deemed to be the date of the dividend payment. The tax implications will depend on the recipient’s marginal rate(s) of tax on dividend income:
- basic rate taxpayers will pay tax at a rate of 7.5%;
- higher rate taxpayers will pay tax at 32.5%;
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taxpayers with income above the additional rate band of £150,000 will pay tax at a rate of 38.1%.
The shareholder of a close company will also be a director, and potentially the release of the loan could be taxed as employment income under ITEPA 2003, s 188, but the section 455 charge takes priority.
This has not stopped HMRC contending that the waived amount should be taxed as earnings. The case Stewart Fraser Ltd v Revenue and Customs [2011] UKFTT 46 (TC) concerned the waiving of a loan to the company’s director-shareholder. The taxpayer contended that the write-off was made in his capacity as a shareholder rather than a director and that therefore could not be considered to be earnings. HMRC successfully argued that the write-off was in fact earnings, which gave rise to a liability to National Insurance contributions (NICs).
HMRC’s case can be simply stated that for the loans to be waived in the taxpayer’s capacity as a shareholder require prior consent, by way of a shareholders meeting. Consequently, all write-offs of loans to participators should be approved by an elected written resolution (under Companies Act 2006, ss 292 and 293) to reduce the potential risk of HMRC objecting.
The waiver may also attract a Class 1 NICs liability if it constitutes remuneration or profit derived from employment within SSCBA 1992, s. 3(1). However, as the Stewart Fraser Ltd demonstrated, so long as proper procedures are followed for loan waivers as above (i.e. a written shareholders’ resolution), it remains possible to avoid an NICs charge.
Anti-avoidance
HMRC has a 30-day anti-avoidance rule to prevent what is termed ‘bed and breakfasting’, i.e. where a loan is repaid shortly before a company’s year-end and a new loan is advanced a few days later in the next accounting period.
Moreover, if a loan is outstanding of £15,000 or more and, at the time of the repayment, there are arrangements or an intention to take out a new loan of £5,000 or more, the repayment is treated as a repayment of the subsequent loan, not the original loan. So even if more than 30 days has elapsed before taking the second loan from the company, the participator is trapped by these rules since the intention was to have the company make a second loan.
Loan benefit-in-kind
Where a company makes a loan to a participator, and either charges no interest, or charges interest below the official rate, a benefit-in-kind is normally levied on the participator.
Where the participator is an employee or director, this will be reported on a form P11D and taxed over the period of the loan at the HMRC official rate (currently 2.25%).
Relief for interest on loans to a close company
Where a participator takes out a loan to repay a loan to a close company, relief may be available, via self-assessment, for the loan interest paid.
Broadly, to qualify for relief, the loan must be either for the purpose of the company’s trade or to repay another qualifying loan. The individual must either own at least 5% of the shares or work full-time for the company and own some of the shares. Anti-avoidance provisions apply.
Summary
- Loan charge under CTA 2010, s 455 is payable nine months and one day after the company year end.
- The liability to the company, calculated at 32.5% of the loan, is payable on the normal corporation tax payment date.
- Anti-avoidance legislation is aimed at catching repayments and replacement borrowing.
- Be careful that a loan write-off is not treated as employment earnings for NICs purposes.
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Benefits-in-kind charge applies to directors, who are normally employees
Practical tip
The rules applying to loans from close companies are subject to extensive detailed provisions. If your company is a close company that has made a loan to a participator, you should consider seeking professional advice on how this will affect both the cashflow of your company and particularly how to reduce the possibility of the waiving/write off of any loan being classed by HMRC as earnings.
