LOAN-RELATED TAX CHARGES

Why are there special rules for directors’ and shareholders’ loans?

Company law allows directors, shareholders and companies considerable freedom over how they arrange their finances. Often the line between the financial affairs of a small or family company and those of its directors and shareholders becomes blurred. For this reason special tax rules apply to companies that are controlled by five or fewer individuals, known as close companies.

A loan is a temporary advance of cash. An advance by a company to one of its participators, that’s someone who controls the management of the company such as a director shareholder, might be for a short term or indefinite.

Without special rules a participator could use their company’s money with only a small tax and NI charge compared to that which would apply if the money were taken by way of salary, bonus, benefits or dividends.

 

Who does the tax charge apply to?

The tax charge applies to companies, i.e. those lending the money, rather than those borrowing it. The loans to participator rules impose a tax charge on the company where a loan remains outstanding nine months and one day after the end of the accounting period in which it was made. The charge is equal to 33.75% of the outstanding loan. Prior to the introduction of anti-avoidance rules it was possible to effectively extend the nine-month period and dodge the tax using a technique HMRC refers` to as “bed and breakfasting”. This involves the borrower repaying the loan shortly before the nine-month period is up only to receive a replacement loan shortly thereafter. The anti-avoidance rules made this technique largely ineffective, other than in relation to low value loans.

Despite the existence of a tax charge on companies and the application of the anti-avoidance rules, properly managed company loans can still be a useful and cheap source of finance to directors and shareholders.

 

What is HMRC’s view of directors’ loans?

HMRC’s Loans to participators toolkit flags some of the common tax and NI problems for companies that lend money and for director shareholders who borrow it. The toolkit itself contains links to other HMRC commentary expressing its, somewhat biased, view on directors’ and participators’ loans.

 

LOANS FROM CLOSE COMPANIES

What counts as a loan?

Anti-avoidance rules apply to loans to participators. In this context, the meaning of “loan” is very wide and covers any loan, credit or advance drawn from the company which is not a payment of salary, bonus, dividend (distribution) or repayment of money which the director has lent the company.

Where a DLA is overdrawn, that is, the participator owes their company money, the balance is a loan for the purposes of the special rules. In other words, a loan can exist even if there is no formal loan arrangement. For example, if a company pays a participator’s personal expenses, unless the transaction it is treated as salary, a benefit in kind or a dividend, they will be indebted to the company.

 

What doesn’t count as a loan?

The loan to participators rules apply to money or money’s worth withdrawn from or charged to a company where it does not count as taxable income. Therefore, payments such a salary, bonuses, benefits in kind, expenses and dividends are not loans. However, an advance on any of these is.

There’s an exception to the above rule for advances of up to £1,000 to a director to cover future business expenses. These don’t count as loans.

Where the director or participator has lent money to their company, any subsequent withdrawal is first treated as a repayment of those funds. Consequently, if the director lends the company £50,000 and then subsequently borrows £20,000, the £20,000 is treated as a part-repayment of the original £50,000 and is not a loan for these purposes. A loan would only arise to the extent that the director or participator borrowed or withdrew more than their loan to the company.

HMRC sometimes disputes this idea, suggesting that the two transactions are to be treated as separate arrangements. You should argue against this vigorously.

As a precaution, to support your argument the board of directors should agree and minute that the arrangements are part and parcel of the same account with the participator. Of course, if in fact the intention was for the transactions to be separate then, in our example, the special rules apply to the £20,000 borrowed.

 

How are trading transactions between a participator and their company treated?

Where a participator purchases goods or services from the close company, the special rules on loans do not apply to a debt incurred in respect of those provided on credit in the normal course of business. That is unless credit is given for more than six months or for longer than it’s normally given to the company’s customers.

 

Are there exemptions for small loans?

Yes, there is a limited exemption from the 33.75% tax charge for certain small loans made to full- time working directors who don’t have a material interest in the company.

Note. Don’t confuse the exemption referred to above with that which applies to the benefit in kind tax charge on the director borrowing the money. 

The exemption from the charge applies if all the following conditions are met:

• the amount of the loan in question plus other outstanding amounts of loan made to the borrower does not exceed £15,000
• the borrower works full time for the close company or any associated company; and
• the borrower does not have a material interest in the company or any associated company.

The £15,000 limit applies per individual and loans to a spouse or civil partner do not have to be taken into account. Each spouse or civil partner has their own limit.

A director or employee is treated as working full time for the close company or any of its associates if they work for at least 75% of the normal working hours of the company.

A person can have a material interest in a company either through share capital or through entitlement to assets on a winding up.

As far as share capital is concerned, a person has a material interest if they, together with their associates (as defined in Section 10) are able to control more than 5% of the ordinary share capital.

A person has a material interest if any of their associates, either alone or with their associates, is able to control 5% of the company’s ordinary share capital. Control of the share capital can be direct, through other companies or by any indirect means.

A person also has a material interest if they alone or together with their associates, has or is entitled to acquire the rights to receive more than 5% of the assets that would be available for distribution on a winding up of a company.

Where an individual becomes a participator with a material interest and at that time they owe the company money, the debt become subject to the special rules for loans. For example, an employee who borrowed from the company is made a director with control over 5% or more of the company’s share capital.

 

What if the close company’s business includes making loans?

Where the “normal business” of the company includes lending money to the general public, the special rules do not apply to a loan made to a participator if it is made on similar terms. To fall within the exemption two conditions must be met:

1. The company must carry on a business of lending money.
2. The loan must be made in the ordinary course of that business.

 

 Are indirect loans caught?

It may be tempting to make the loan by a circuitous route in order to avoid triggering the loan to participator rules. To counter this HMRC treats certain arrangements as loans even though at first sight they might not appear to be. This applies where:

• the close company makes a loan or advance which does not otherwise give rise to a charge under the loans to participators rules
• a person other than the close company makes a payment or transfers property to wholly or partially clear the loan; and
• arrangements exist for the loan to be transferred or released.

The tax rules for indirect loans are best illustrated through examples.

Example 1

Sunflower Ltd is a close company. Rather than making a loan to David, a participator, it makes it to Tulip Ltd, which is an associated company. Tulip Ltd then makes the loan to David. The loan is treated as if it had been made by Sunflower Ltd to David and is within the scope of the loans to participators rules.

Example 2

Company A makes a loan to Andrew. Andrew is a participator in company B, but not in A. Under arrangements between A and B, B makes a loan to Julie, who is a participator in A but not B. Although neither company makes a direct loan to a participator, loans are made to participators under an arrangement where company A makes a loan to a participator in company B and company B makes a loan to a participator in company A. The arrangements count as indirect loans and so are caught by the loans to participators rules.

 

What about loans to partnerships and trusts?

Company loans to a partnership in which a participator is a partner also fall within the special rules. The scope of the rules affecting business partners was widened in a bid to stop the use of partnerships as a way to avoid the loans to participators rules.

 

When do the rules for loans to partnerships apply?

Loans by close companies to a limited liability, or other type of partnership in which at least one partner is either a participator or an associate of a participator are caught by the rules. Since the same date, loans or advances to trustees of a settlement in which at least one trustee or beneficiary (or potential beneficiary) is a participator or an associate of a participator are also caught.

Example

Polly is a participator in Orchid Ltd and also a partner in a limited liability partnership. Orchid Ltd makes a loan to the LLP. The arrangement is within the scope of the loans to participators rules.

Loans made to a partnership in which a participator is a partner may be caught by the loans to participators rules, even if at least one partner is a company.

 

TAX CHARGE ON LOANS (THE S.455 CHARGE)

When does the charge apply?

A tax charge is imposed by s.455 of the Corporation Tax Act 2010 where a loan is made to a participator and that loan is wholly or partially outstanding nine months and one day after the end of the company’s accounting period. This is often referred to as a “s.455 charge”.

Where the loan is fully repaid within nine months of the year end, there is no s.455 charge.

Anti-avoidance rules mean that it is no longer possible to escape the charge by repaying the loan shortly before the nine-month date and taking out a new loan just after it. This “bed and breakfasting” of loans is caught by anti-avoidance rules.

 

Will HMRC refund s.455 tax?

A s.455 charge is a temporary tax. If and when the loan is repaid the tax is refundable by HMRC nine months and one day after the end of the accounting period in which the loan is repaid. A partial repayment of a loan triggers a corresponding partial refund from HMRC.

Timing the repayment of a loan is important. If a director or participator leaves it until a day after the end of their company’s accounting period, the s.455 tax refund will be delayed by a year.

 

How much is the charge?

The tax charge is equal to 33.75% of the loan remaining outstanding nine months and one day after the end of the accounting period in which it was made. This is the date by which corporation tax for the period is due.

Example

Billy is a participator and director in his family company, Elm Ltd, which is a close company. The company prepares accounts to 31 March each year.

In its financial year to 31 March 2023, Billy borrowed £20,000 from Elm. He repaid £5,000 of this on 6 October 2023. £15,000 remains outstanding on 1 January 2024 - nine months and one day after the end of the accounting period in which the loan was made.

Elm must pay tax of 33.75% of the balance of the loan outstanding at that date, i.e. £5,063.

 

When is the tax due?

The tax is due on the normal due date for corporation tax, i.e. nine months and one day after the end of the accounting period. Although, strictly speaking, the tax is not corporation tax, it is payable with the company’s corporation tax for the period and HMRC will charge interest if it’s paid late.

Example

In the earlier example, Elm Ltd must pay tax of £5,063 in respect of the outstanding loan to Billy, together with any corporation tax for the year to 31 March 2023, by no later than 1 January 2024.

 

What is bed and breakfasting?

At one time is was possible to avoid the s.455 charge by repaying a loan shortly before the end of a company’s financial year end and borrowing the money again shortly after. The same repay and re-borrow method was also effective around the nine-month deadline (nine months from the end of the financial period in which the loan was made).

However, anti-avoidance rules now make bed and breakfasting ineffective in avoiding the charge. There are two bed and breakfasting anti-avoidance rules:

1. The “30-day rule”
2. The “intentions and arrangements” rule.

 

How does the 30-day rule work?

The rule comes into play where, within a period of 30 days of a repayment of more than £5,000, the participator borrows again from the company.

Remember that a loan to an associate or a partnership to which a participator belongs counts as a loan to the participator.

The s.455 tax applies to the lesser of the amount of the loan repaid and the amount re- borrowed. The repayment is ineffective to the extent that the funds are re-borrowed within 30 days.

Example

Basil Ltd is a close company. On 1 January 2023 it lent £25,000 to Derek who is a director and owns 30% of its shares. Basil’s accounting year runs to 31 December. The date which is nine months and one day from the 31 December 2023 year end is 1 October 2024. On 20 September 2024 Derek repays £6,000 of the loan, but on 10 October 2024 he borrows another £4,000 from his company. Because the amount of loan repaid is more than £5,000 and there is further borrowing within 30 days, the anti-avoidance rule applies. The amount of loan repayment that will be ignored when working out the s.455 tax is the lesser of the loan repaid and the amount of further borrowing, i.e. £4,000.

Basil Ltd must pay s.455 tax on £21,000 (£25,000 - £4,000). At 33.75% the tax payable on this is £7,088.

It doesn’t matter which comes first, the loan repayment or the further borrowing, the 30- day period applies equally. This prevents a participator taking a new loan and using it to repay all or part of the original one.

 

Can the 30-day rule be avoided?

Where your company pays you a dividend, bonus or any other payment that’s taxable and it’s used to repay part or all of a loan, the 30-day rule doesn’t apply. In other words, it’s OK for you to take another loan from your company within 30 days without the anti-avoidance rule being triggered.

Example - cash repayment of loan

Rose Ltd is a close company in which Helen is a director and sole shareholder. Rose Ltd prepares accounts to 31 May each year.

On 1 April 2023 Helen withdrew £20,000 from the company by way of a loan.

On 20 February 2024 the company declared a dividend of £12,000 for Helen. On 20 February 2024 she uses the dividend she received to reduce her debt to the company. On 28 February 2024 Helen repaid the remaining £8,000 from cash in her bank account. Therefore on 1 March 2024 (nine months and one day after Rose’s year end) the loan balance was nil. On 10 March 2024 Helen borrowed £2,000 and on 15 March a further £4,000.

The 30-day rule applies because within 30 days of repaying the £20,000 (£12,000 on 20 February 2024 plus £8,000 on 28 February 2024) she withdrew £6,000 (£2,000 on 10 March and £4,000 on 15 March).

The effect of the bed and breakfast rules is that the £6,000 Helen re-borrowed is liable to a s.455 charge.

Example - repayment of loan by book entry

If the £12,000 dividend was credited to Helen’s DLA instead of than paid to her, it reduces the amount she owed to Rose Ltd but does not trigger the anti-avoidance rule because of a quirk in the rules. They are worded so that loan repayments made by book entry, e.g. a credit of a dividend or salary against the debt owed by a participator, don’t count as repayments for the purpose of the anti-avoidance rules.

However, the £8,000 repayment by Helen is a repayment for the purpose of the anti-avoidance rules. As it exceeds £5,000 and is followed by new borrowing of £6,000 (£4,000 + £2,000) within 30 days the anti-avoidance rules apply.

S.455 tax of £2,025 is payable (£6,000 x 33.75%).

Repayments are ineffective in clearing a loan to avoid a s.455 charge if some or all of the funds are re-borrowed within 30 days and the amounts involved are more than £5,000.

Keep the repayments and subsequent re-borrowings below £5,000 for the repayments to be effective in reducing the s.455 tax payable but beware the intentions and arrangements rule.

If funds are needed within 30 days of a repayment and there are sufficient retained profits, consider declaring a dividend and using it to reduce a participator debt through a book entry in the company’s records.

 

What is the “intentions and arrangements” rule?

The intentions and arrangements rule bites where the balance of the loan outstanding immediately before the repayment is at least £15,000, and at the time a loan repayment is made there are arrangements, or an intention, to subsequently borrow £5,000 or more.

This rule applies even where the new borrowing is outside 30 days. The rule bites if the repayment is made with the intention of redrawing at least £5,000 of the payment, irrespective of when this is done. Again, the rule does not apply to funds extracted by way of a dividend as these are within the charge to income tax.

Example

Jack is a participator in Gerbera Ltd. It’s a close company and prepares accounts to 30 April.

On 31 March 2023 Jack borrowed £30,000 from the company. The loan remains outstanding at the end of the accounting period on 30 April 2023. Unless the loan is repaid before 1 February 2024 a s.455 charge will arise in respect of the loan.

On 25 January 2024, Jack takes out a short-term loan from the bank for £30,000, which he uses to repay the loan on 28 January 2024.

On 18 March 2024 he borrows £30,000 from Gerbera and uses it to repay the bank loan. Although this borrowing occurs more than 30 days after the date on which the repayment was made (meaning that the 30-day rule cannot apply), at the time the he took the bank loan it was Jack’s intention use it to repay the bank loan - the intentions and arrangements rule therefore applies.

The repayment of the £30,000 by Jack to Gerbera is therefore ignored and a s.455 charge of £10,125 (£30,000 x 33.75%) is payable.

Arrangements to re-borrow up to £5,000 are not caught by the rule. Making a repayment of up to £5,000, even if the intention is to borrow it again, is effective in reducing a s.455 charge.

 

How are repayments and withdrawals matched for the purposes of these rules?

In practice, a director may withdraw and repay money within a short period of time. Where amounts are debited and credited to a DLA, technically each debit is a new loan and each credit, a repayment.

Anti-avoidance rules apply so that repayments can’t necessarily be used to clear an older loan before a later one. This mean the usual first-in first-out basis for clearing debts doesn’t even where the gap between the loan and the repayment is more than 30 days.

Example

Caroline is a participator in Lily Ltd, which is a close company. It prepares accounts to 30 June each year.

On 1 May 2023 Caroline borrowed £20,000 from the company. This remains outstanding on 30 June 2023.

Unless the loan is repaid by 1 April 2023 the company will need to pay s.455 tax on the outstanding loan. On 31 January 2024 Caroline borrows a further £25,000 and uses some of it to repay the original £20,000 debt before the 1 April 2024 deadline.

HMRC will not accept that the original loan was repaid and will treat the £20,000 repayment as being a partial repayment of the new loan. Consequently, the company will need to pay s.455 tax of £6,750 (33.75% of £20,000) on the original £20,000 loan.

Taking a new loan after the end of an accounting period and using the new funds to repay the original loan is unlikely to be effective in avoiding the s.455 charge. HMRC will argue that it should be matched with the later loan.

 

What happens if the loan is repaid after s.455 tax has been paid?

S.455 tax is unlike other tax in that it’s repayable after the loan in respect of which it was charged is repaid or otherwise cleared, e.g. written off.

The tax paid can be reclaimed nine months and one day after the end of the accounting period in which the loan was repaid, released or written off. However, there’s a limited window for making the claim as it must be made within four years of the end of the accounting period in which the loan was cleared. If the claim isn’t made within this time, the relief is lost and the tax can’t be returned.

The relief isn’t given automatically. It must be claimed on your company’s self-assessment corporation tax return CT600 or by completing Form L2P.

Example

Betty is a participator in Pear Tree Ltd, which is a close company. The company prepares accounts to 31 March each year.

In the year to 31 March 2017, Betty received a loan of £10,000 from the company. The loan remained outstanding on 1 January 2018 and the company paid s.455 tax of £3,250

In January 2024 Betty inherits some money and uses it to repay £10,000 to Pear Tree. The loan is repaid in the accounting period ending on 31 March 2024.

The company can make a claim for relief for the s.455 tax paid on or after 1 January 2025 (nine months and one day from the end of the accounting period in which the loan was paid). The claim must be made by 31 March 2028 - four years from the end of the accounting period in which the debt was repaid.

 

REPORTING TO HMRC

Do I need to tell HMRC about the loan?

It might be necessary to tell HMRC about an outstanding loan, even if there’s no s.455 tax to pay. The reporting requirements vary depending on when or whether the loan is repaid.

 

Loan repaid before the end of accounting period in which it is made

If a loan is made to a participator in a close company and repaid before the end of the accounting period in which it was made, it doesn’t need to be reported to HMRC.

Example

Sarah is a participator in and a director of Orchid Ltd, in which she owns 100% of the shares. The company prepares accounts to 31 March each year. In December 2023 she borrows £6,000 from the company. The loan is repaid on 1 March 2024. As the loan is repaid before the end of the accounting period in which it was taken out, it doesn’t need to be reported to HMRC.

If the loan is repaid before the end of the accounting period, details don’t need to be disclosed to HMRC and there’s no tax to pay.

 

Loan repaid after the end of the accounting period but before due date for corporation tax

Where a loan by a close company to a participator remains outstanding (wholly or partially) at the end of the accounting period in which it was made, it’s necessary to include details on the company tax return for that accounting period. If the loan is cleared within nine months and one day of the end of the accounting period, there is no s.455 tax to pay (unless the repayment is rendered ineffective by virtue of the new 30-day or intentions or arrangements rule).

Example

Sian is a participator in and director of Calla Ltd, in which she owns 100% of the shares. The company prepares accounts to 30 April each year. In January 2023 she took a £10,000 loan from the company. She repaid £5,000 on 20 April 2023 and the remaining £5,000 on 30 June 2023.

As £5,000 remained outstanding at the end of the accounting period she needs to report the loan to HMRC. However, as it was repaid before 1 February 2024 (the due date for corporation tax), she doesn’t have to pay any s.455 tax in respect of the loan.

If the loan remains outstanding at the end of the accounting period, it must be reported to HMRC.

 

Loan outstanding nine months and one day after end of accounting period

If the loan is not paid off within nine months and one day of the end of the accounting period, details must be included on the company tax return and s.455 tax paid on the balance outstanding at that date.

If the loan is not repaid within nine months and one day of the end of the accounting period, it must be reported to HMRC and s.455 tax paid on the outstanding balance.

 

How are details of the loan reported?

Where details of the loan need to be returned, this is done by completing the directors’ loan section on the online CT600 return. This section of the return is used to disclose details of relevant loans and to calculate the amount of the tax due. The return must be made within twelve months of the end of the accounting period.