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Section 419 - Loans to participators

A participator has an overdrawn loan account at the company year end. Within nine months this entire loan is repaid, but it is replaced by a new series of transactions creating a new overdrawn balance.

Is the original loan treated as being repaid and thus 419 relief is due when the CT return is filed? Or is the maximum relief available restricted to the new overdrawn balance?

Comments gratefully received!
Simon

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By wdr
07th Mar 2003 15:15

Postscript from New Enquiry Handbook published today

EM8623 - Close Companies: Settlement: Writing off or Releasing the Director's Loan


Where a loan made to a participator who is an employee is written off or released, the sum involved usually satisfies the definition of earnings in Section 3(1) Social Security Contributions & Benefits Act 1992 and thus is regarded as earnings for the purposes of calculating Class 1 NICs.

After 5 April 1999 relief under ICTA88/S419(4) can be obtained where a debit loan balance is written off or released by the company. This might be used rather than the company being reimbursed by the director(s) to obtain S419(4) relief to reduce the net amount required to be paid under a contract settlement. Where this is proposed you should warn the company about the Class 1 NIC liability and, unless the liability is covered by the settlement arrangements, notify the appropriate Employer Compliance Unit to pursue this with the company.

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By wdr
24th Feb 2003 21:37

Jay, I apologise on FA1998 s.24. but I stick to my guns on two p
Apart from any charge under s.419[a "loan "to the Revenue while the loan subsists], there will be an annual benefit to any employee to whose relative a loan has been made, and the employee, not the participator will suffer an annual s.160 charge.

In the event that neither the participator nor a relative is an employee, the nightmare of s.418 raises its head.
That has two consequences:-

a]the participator is deemed to be receiving annual distributions equal to the sum which would otherwise be a s.160 charge-so would if a higher rate taxpayer suffer each year a charge of 25% of the notional distribution

AND,
in the view of the Revenue, a sum equal to the deemed distribution has to be added back in the CT computations-see Revenue Manuals:-

"6601. Close companies: profits chargeable to CT

No deduction is allowable (either in computing income from any source or as a charge against total profits) for expenses incurred in providing benefits for participators or their associates, which come within the extended meaning of distributions for close companies (see ICTA 1988, S 337(2) andICTA 1988, S 338(2))."

In the case of interest, if the company has no borrowings, both a s418 charge and the add back for CT may be resisted[and the addback should be anyhow, as the Revenue interpretation is somewhat eccentric and unsupported by the Courts-look at Bricom for the impact of a deeming provision].

Don't ignore the consequences of company law-it really is ultra vires to fail to pursue a debt knowing that the debtor can pay-very few Mem & Arts will allow the company to make gifts to all and sundry.I suspect the Revenue would argue this point as well if a loss were claimed under the loan relationship rules, arguing that there is no consideration for writing off the loan ,so that it remains an asset of the company. Would the accounts comply with company law ? if the company requires an audit, what is the auditor's opinion going to say?

Just to add a bit of fun to the argument, if the borrower is non resident when the loan is written off, no s421 charge may arise , as the charge would fall in the "other income"provision of a number of double tax treaties, in particular that with the most popular destination for tax emigres-Belgium



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22nd Feb 2003 21:04

Reply to Red Queen

Red Queen,

The company recovers any tax paid under Section 419 in the same way as if the loan is repaid. The new legislation was enacted in Para 24, Schedule 3 FA 1998.

You will need to scroll down the page to get to PARA 24 changes to th main Act.

To actually make the claim, the company needs to complete Form CT600A - Loans to participators by close companies Supplementary Pages.

Wife is not an employee so section 160 does not apply. In any case, Schedule F tax takes priority over schedule E according to Inland Revenue Manuals: ACT: tax credit: FA93: ICTA88/S421 loan released/written off: IT treated as deducted.

I don't see how it could be argued that wife has got the loan by reason of husband's employment when she is already a shareholder of the company. I am however, open to be convinced.

I have ignored company law matters because these don't normally apply to owner managed businesses. Directors tend to give personal guarantees for loans etc and so there is no question of them being prosecuted. Creditors are not likely to lose anything because the only motive is to give wife tax free income by giving her "dividends".

The reason this method could be attractive is because other shareholders (mainly family members) don't have to wave their rights to dividends.

Hope this helps.


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23rd Feb 2003 19:30

We need to consider Relief under Loan Relationship Regulations a

Harry Ross,

Thank you for pointing out Inland Revenue's own website for legislation. I shall start using this from now onwards.

The other thing we need to consider about loan write offs is whether these qualify for relief under the Loan Relationships Regulations of Finance Act 1996. There are restrictions in cases where the loan is between connected persons but Finance Act 2002 (Para 8 schedule 25) has made subtle but substantial changes in the meaning of control (and therefore connection) as follows:


"87A Meaning of "control" in section 87

(1) For the purposes of section 87 above, "control", in relation to a company, means the power of a person to secure-
(a) by means of the holding of shares or the possession of voting power in or in relation to the company or any other company, or
(b) by virtue of any powers conferred by the articles of association or other document regulating the company or any other company, that the affairs of the company are conducted in accordance with his wishes.


I am still working on this but any input from the members would be appreciated.

Regards,

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21st Feb 2003 20:55

S 419 is a temporary problem

In my opinion, Section 419 is temporary cash flow problem. When the loan is repaid, the amount "lent" to the the Inland Revenue is also repaid. Going via trust route for this purpose is an overkill!

Also, more and more companies are using the tax rules to distribute uneven dividends to the non working sharholding spouse using the loan write-off.

For example, A company might give a loan of £30,000 to wife who is not an employee but is a participator. After the year end, the loan is written off and so the company can recover Section 419 tax but spouse has benefited from the "distribution" whereas non of the other participators had this benefit!

Other participators could be employees and so they get a salary in the normal way.

Perhaps, this is yet another way of giving dividends to the spouse without affecting other shareholders.

Any comments on this Mr Ross?

Regards,

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By wdr
22nd Feb 2003 19:36

Jay-how does the company recover the 419 payment if the loan is
A loan to a participator wife will still fall within the s.160 benefit rules , giving rise to a s.160 charge to the employee husband.

Writing off the loan is probably ultra vires[indeed the loan itself could be!] , if the company makes no attempt to recover the loan, and a subsequent liquidator might well seek to recover the loan from the wife.

But under which provision does a s421 situation give rise to a recovery of a previous s.419 liabilty ??

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By wdr
20th Feb 2003 19:40

known to Revenue as "bed and breakfasting-they do not approve!!
Manuals read
Close companies: repayment etc. of loan: bed and breakfasting [6662]
ICTA88/S419 (4)BED AND BREAKFASTING
You may find that a participator’s indebtedness to the company is shown as reduced or eliminated immediately before the accounting date, or before the due date for payment of the Section 419 tax, only to be followed by a fresh loan or advance of the same or of a similar amount soon afterwards.
The temporary reduction in indebtedness is often brought about by the participator borrowing funds on a short term basis from a third party such as a bank. But it may come from a transfer of assets to the company, or a transfer from another account with the company. You may come across other schemes for ‘bed and breakfasting‘ the debt.
Where you find bed and breakfasting, you should get full details of the transactions, including copies of any relevant bank statements and refer to the guidance in IH7150.

The approach to "bed and breakfasting" is set out in the Investigation Handbook as follows:-

Remember that cases of ‘bed and breakfasting’ are regarded as incorrect accounts attracting penalties under Section 96

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By Anonymous
26th Feb 2003 22:35

We aren't the only country to levy tax
The problem with dividendsin some countries is that they are taxable! S.421 charges are a notional charge. The offshore route is interesting in a number of cases, as is the drafting of s.421.

A simple ploy is to lend money to a participator and merely to fail to recover it formally for 6 years. It is then irrecoverable, and provided the company merely provides 100% against the debt, rather than writing it off, and provided the borrower never acknowledges the debt, s.421 cannot apply even onshore, as the loan has neither been writrtten off nor waived!!
I am signing off on this issue now, I think we have gone on long enough.

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By DConlan
21st Feb 2003 16:32

How Overdrawn?
What is the potential s.419 liability? If it is large, it may be worth considering the use of a trust (or trusts) to remove the loan to participator element. It is most likely that no CT relief would be available on the transaction and the beneficial loan charge would still apply, but the s.419 issue could be overcome-at a cost. Using two trusts should be able to overcome the FRS5/UITF 13/UITF 32 issues although not the impact of the new legislation for the timing of tax relief on such contributions. [email protected]

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21st Feb 2003 01:48

What you need is a working model!

I agree everything written by Red Queen but Simon I am sure you want a way forward if you have such a situation.

What you have to do is to take the opeing balance and closing balance of the loan account and find the difference. If there is a reduction then there is repayment, otherwise futher loan.

For reduction you make a claim for repayment of any tax paid; for increase you simply pay further tax at 25%.

You might have to do an exact method for BIK purposes if this is applicable.

Hope this helps.

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27th Feb 2003 01:36

We have done enough work on this and perhaps revisit it again!

Thanks Red Queen, Harry Ross and original querist. We should leave it at this stage and perhaps revisit it when we have something new to add.

I am sure we do need more work on this.

Best regards,

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