Tax implications from loans to participators made by close companies

 

The Autumn Budget 2021 confirmed that the increased dividend upper rate will apply on tax charged under Corporation Tax Act 2010, s.455, which details new anti-avoidance measures in addition to those already in place for loans to participators in close companies. Let’s take a look at what this all really means.

 

First things first, what are close companies?

A company that is owned and controlled by no more than 5 individual participators (or controlled by any number of directors only). Key terms to note here are:

  • Participator: A person who has the right to be a company shareholder or ‘loan creditor’.
  • Control An individual has control if they own (or have the right to) more than 50% of company shares or voting powers.
  • Loan Creditor: A person who has lent the company money but does not include a normal trade creditor.

These definitions are interesting because it allows participators to enjoy tax-free funds which can be taken out of the company as loans. These loans can also remain for an indefinite amount of time, which is precisely why anti-avoidance rules were put into place under CTA s.455

 

Who do these rules apply to?

The rules apply to:

  • Loans to participators who are individuals or trustees, but not companies
  • Loans to associates of participators
  • Loans to partnerships (including limited partnerships, LLPs)
  • Companies that lend to an employee’s benefit trust

If a loan qualifies under these rules, the close company must pay tax equal to 25% (of loan made before 6 April 2016), or tax equal to 32.5%* (of loan made on or after 6 April 2016) directly to HMRC. The close company is exempt if the loan was repaid within nine months and one day from the end of the accounting period where the loan was made. The close company can also claim to recover the tax paid to HMRC when the loan is waived by the company.

It is important to note that this tax is classed as a liability under CTA s.419, so it should be included in the company CT self-assessment. Additionally, the individual who received the loan is liable to income tax on it.

*From April 2022 this rate will increase to 33.75%.

 

What about indirect loans?

Suppose two or more close companies arranged to transfer a loan via a third party (say, a bank), are they also affected by these anti-avoidance rules?

The same rules still apply provided that:

  • A close company makes a loan that does not result in tax under participator provisions
  • An individual (other than the close company) makes a payment, property transfer, or releases or fulfils a liability of a participator or associate in the company

Interestingly, this rule seems to work against arrangements made by any person. However, it does not apply to arrangements made in what would otherwise be considered ‘ordinary’ business and does not apply if the relevant recipient has the loan included in their total income. ‘Ordinary business’ implies that a company must make loans as part of its day-to-day trading.

HMRC illustrates this example very well:

Company H is a close company. Instead of making a loan directly to Mr A (an individual participator), they make a loan to an associated company, Company J. Company J then loans the money to Mr A.

In this case, the loan by one company to the other is treated as if it had been made direct to Mr A.

 

Loan aggregation

It is not too uncommon to see companies opt to have separate loan accounts for the same participator in the interests of admin work or commercial ease. HMRC hold the position that the close company liability on loans follows each of the loan accounts – hence it cannot be aggregated.

Any account showing a debit balance will incur liability under the rules. HMRC advise that credit balance can be used to repay the debit, but book entries have to be made for relief to be awarded. A company can also choose to have a singular loan account for all participators given that they are all separately recorded in the account, meaning that the close company loan charge and repayment relief would apply to each separate account.

 

Have any more questions?

Feel free to contact us for professional advice and guidance on how these rules can affect the cash flow of your company.

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