Lee Sharpe looks at the potential issues of taxing loans to director/shareholders of family companies.
Introduction
This article considers tax aspects of a family company making loans to a director/shareholder, and in particular where the loan is written off or “waived”. When referring to “family companies”, we mean “closely controlled”, generally by five or fewer shareholders – a typical OMB or family company setup.
By “director/shareholder”, we mean someone who is both a shareholder and an employee of the company – usually a director.
“Loans to participators” describes where the company makes a loan to an individual who has a stake in the company. This usually means a shareholder (or someone entitled to shares) although it can include someone who is a loan creditor – we shall use “shareholders” for simplicity.
We shall briefly cover the taxes at stake when making loans to director/shareholders, while concentrating on particular risks and opportunities.
Benefit-in-kind
Director loans are usually (but not necessarily) made on an interest-free basis. Tax law deems that an employer-arranged low-interest or no-interest loan is a “perk” assessable as a Benefit in Kind, on the difference between the interest paid (if any) and what HMRC thinks is a commercial rate – currently just 2%, in 2022/23. So, an interest-free loan of £20,000 to a director for all of 2022/23 will cost £20,000 x 2% x 12/12 = £400pa – the employee will have to pay tax on notional income of £400 (the employer is liable to secondary NI contributions as well).
Note that:
- HMRC’s interest rates have been quite low for many years, and the personal tax cost quite modest in turn, but
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The charge broadly lasts as long as the loan is made – so can mount up over several years
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HMRC’s official interest rate is expected to rise significantly from April 2023, in line with “real” interest
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- There is a minimum threshold of £10,000 below which loans are not caught, but
- The company cannot get away with several concurrent loans of £9,999 to the same employee, and
- As soon as the overall loan balance exceeds £10,000, the charge applies for the entire tax year (or the life of the loan if shorter) even for periods where balances start or end, etc., below £10,000
- The basic loan benefit calculation applies only if the loan is outstanding for a complete tax month so in theory, a short-term loan triggers no taxable benefit, even if very substantial. However, HMRC can apply a more precise “daily basis” calculation if the sums are worthwhile.
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There is no taxable benefit if the interest on the loan would be tax-allowable to the director – say if the funds were then applied in their sole trade, or certain personal property business scenarios.
Temporary corporation tax charge – Loans to participators
Typically, the family company will be more concerned about being caught out by Corporation Tax on the loan to the individual as a shareholder under CTA 2010 s 455 – the “s455 tax charge”.
Very simply, if the loan is still outstanding for more than 9 months and a day after the end of the period in which the loan was made, then the company has to pay across a temporary Corporation Tax charge, currently at 33.75% of the loan still outstanding. As and when the loan is repaid, in whole or in part, then the company can reclaim repayment of a corresponding amount of s455 tax – but it can take many months to get the s455 tax back, once it has been paid over to HMRC.
Waiving the loan
The company also has the option to waive or ”release” the loan. The effect is that the forgiven director/shareholder is then deemed to have received a distribution – taxed as a dividend – from the company, at the date on which the loan is formally released.
The potentially significant benefit of this is that the director/shareholder may have enjoyed the use of the money borrowed for some time and suffered a quite small benefit-in-kind tax charge in the interim, (potentially several years), and then pay a relatively efficient tax charge at the dividend rates in order to make the funds permanently their own. This can “delay” the main tax cost by some margin.
Example
Nadim, who already pays tax at the Additional Rate, owns 50% of the shares in the family company.
He takes a loan of £100,000 in late March 2023, to help him buy a new residence. The company formally waives the loan on 30 April 2025.
For 2 years, Nadim will have a Benefit in Kind tax charge:
£100,000 x 2%pa (for now) = £2,000 @ 45% Additional Rate = £900pa in Income Tax 2023/24, and 2024/25; then
£100,000 x 39.35% = £39,350 for 2025/26, payable 31 January 2027.
If Nadim had taken a dividend immediately in March 2023 instead, then he would have had to fund the £39,350 on 31 January 2024, so his main tax charge has been deferred by 3 years (the company’s small NIC, and s455 considerations aside).
Waive carefully
Writing-off is not waiving – A formal debt release is not the same as “writing off” the loan. For example, a company can still try to recover a loan that it has written off even if it does not expect to get the money back. A debt waiver or release is effectively turning the loan into a gift, and has to evidenced in writing to be legally effective – legal advice is recommended.
When to waive? – For example, waiving the debt on 6 April instead of 5 April will put the director/shareholder’s corresponding deemed distribution into the next tax year, giving them an extra year to fund their tax bill; but it may make no difference at all to the company, depending on its own accounts year.
Which loan? – If there is more than one balance due from the director/shareholder, be clear on which debt is being released, as it will be important for the company when managing its s455 obligations.
Don’t forget the s455 tax – If the debt has been on the books for a while and the company has paid s455 tax over to HMRC, waiving the debt starts the reclaim clock just like repaying the loan would do, meaning the company will then have (very roughly) 4 years to request a refund from HMRC.
Don’t plan to waive – It seems likely that HMRC would argue strongly that a loan that the company intends from the outset to release at some point in the future is not actually a loan. That is different from a genuinely repayable loan, that the company at some later point decides to release.
Is salary cheaper? – Corporation Tax rates will increase to 25%+ for larger companies from April 2023, so it may in some scenarios be slightly more tax-efficient overall to pay a bonus than a dividend. At the time the shareholders are deciding whether to formally forgive the loan, they should check if it is cheaper to take a bonus and actually repay the loan from the net proceeds.
Who decides to waive? – HMRC may argue that the loan waiver constitutes earnings for the purposes of NICs, because the decision is being made to waive a loan to a director (employee). It may be inferred that, if the decision is made at a shareholders’ meeting, rather than by the directors at a board meeting, then the waiver may not be assessed as earnings – from Stewart Fraser Ltd v HMRC (2011) UKFTT 46 (TC) (even though the taxpayer lost that particular case).
No Corporation Tax Relief – It used to be argued that the company could claim tax relief for writing off such loans, but that was officially blocked in 2010 – see CTA 2009 S321A.
Conclusion
Loans to director/shareholders can become quite complex and nuanced. But they can be worth the effort, as a relatively cheap means to access surplus company funds without a prohibitive tax charge. Advice is recommended when contemplating a substantial loan, or when deliberating over its release.
