Interest on beneficial loans

Charging interest to avoid a taxable benefit

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Hi all,

I wanted to run something by you.

A close limited company client of mine has a directors' loan account which was in excess of £10,000 owing to the company in certain months of the period of account. This will continue to happen in future years.

What I was wanting to do was to calculate the interest payable on the loan, at 1/12th of the HMRC official rate multiplied by the month end balance of the director's loan account for any month in excess of £10,000.

My questions are whether this method of calculating and charging interest is effective in avoiding the taxable benefit of a beneficial loan if:

  1. The interest is not paid in cash, but instead entered into the books as increasing the directors loan; is this still deemed to be a payment of interest (I always thought it was, but now have doubts, having read (https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim26251)
  2. The above mentioned 'payment' of interest happened after the year end.
  3. (because this will continue into future years) The obligation to pay interest during the year was in the form of a board minute stating that 'interest will be charged on any loan greater than £10,000 at the end of any month at the pro-rata amount of the HMRC official rates for beneficial loans.'

Many thanks

Oliver

Replies (22)

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By Tax Dragon
15th Jun 2018 07:20

Oliver, this is one for the company's accountant. The easiest way to avoid the tax charges is not to have a loan.

In reverse order, accruing for interest is not paying interest; interest has to be interest - you need to know in advance whether it will arise, your method requires hindsight; and no, that's not how the BIK calculation works and your method (even ignoring the other points) may not avoid a BIK.

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By chicken farmer
15th Jun 2018 09:40

Why do we get so concerned about not paying tax?Isn't it cheaper for the employee to pay the tax rather than pay interest?

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By johngroganjga
15th Jun 2018 15:57

Tax is dead money because it goes to a third party and never comes back. Interest going into your company is not dead money - it’s still yours, if the company is.

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Replying to johngroganjga:
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By chicken farmer
16th Jun 2018 11:03

But, it isn't his money, is it? The problem with most small company director/shareholders if that they think the company's money is theirs and end up in a mess.

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Replying to chicken farmer:
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By tonycourt
16th Jun 2018 11:28

John's right.

To the extent money adds to net assets, shareholders have a right to it (in fact they are the only ones entitled to it), whereas if you pay the tax it belongs to the state.

While the "company money is not your money" is a good and valid mantra for errant clients who don't understand the relationship between say, what's in the bank, what's distributable or that the company can afford to pay and the tax consequences of doing so, that's not who we're dealing with here, so we can dispense with the "it's not your money point" and go straight to the what will produce the best financial result within in the circumstances.

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Replying to chicken farmer:
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By tonycourt
16th Jun 2018 11:28

John's right.

To the extent money adds to net assets, shareholders have a right to it (in fact they are the only ones entitled to it), whereas if you pay the tax it belongs to the state.

While the "company money is not your money" is a good and valid mantra for errant clients who don't understand the relationship between say, what's in the bank, what's distributable or that the company can afford to pay and the tax consequences of doing so, that's not who we're dealing with here, so we can dispense with the "it's not your money point" and go straight to the what will produce the best financial result within in the circumstances.

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Replying to chicken farmer:
By johngroganjga
16th Jun 2018 19:17

If the company is his, so is ultimately the money it its bank account.

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Replying to johngroganjga:
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By Tax Dragon
17th Jun 2018 08:57

So why not simply pay interest on the whole amount? Beats phaffing around in the way suggested (and paying your accountant to do the maths) - even if the idea worked, which I question.

Seriously, how much tax are we talking about here? Couple of hundred quid for a 40% taxpayer? Actually less than that, isn't it.

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By tonycourt
15th Jun 2018 10:21

CF's point is a good one, but of course there might be other reasons for paying interest.

I think HMRC's view on balance is correct i.e. interest must be paid and a book entry won't suffice. However, I would challenge that where the director's loan account is in credit.

The payment of interest can be made at any time up to the point at which the tax liability would be final and conclusive - I take that to be one year after the usual self-assessment filing date. Loan interest was the one exception to the alignment of making good dates which has applies since 6 April 2017.

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Replying to tonycourt:
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By ocooper
16th Jun 2018 11:51

Thanks Tony. I'm unclear on the fact that 'Loan interest was the one exception to the alignment of making good dates which has applies since 6 April 2017' - can you please clarify what you mean, or let me know where to look, as I couldn't seem to find anything on this.
Thanks
Oliver

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Replying to ocooper:
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By tonycourt
18th Jun 2018 12:54

Section 1 Finance(No2) Act 2017 included amendments to the various benefit in kind charging provisions so as to align the dates by which making good (paying or reimbursing the employer for providing the benefit) a benefit reduced the taxable amount (https://www.gov.uk/government/publications/dates-for-making-good-on-bene...).

Beneficial loans were not included in the Finance (No2) Act amendments and so the original making good deadline applies to them. I always took the view that this date was when the assessment (or self-assessment) became final and conclusive, but HMRC's booklet 480 (paras 17.33 - 17.35) suggests the deadline as at which applies for overpayment relief, i.e. the 5th April four years from the end of the year of assessment. However, my understanding is that the date to remove any liability to class 1A is (and always has been) 6 July following the end of the year of assessment.

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By David Heaton
15th Jun 2018 13:26

Interest is only 'paid' if money changes hands - book entries don't work. That's not an opinion, that's the law, and has been for a very long time, for this type of loan. The courts decided 80 years ago that a company issuing funding bonds in purported payment of interest on existing loan notes had not paid any interest, it had just issued a promise to pay some interest, and the same applies to book entries in an overdrawn loan account. That principle has been changed for companies - it now amounts to payment - but not for individuals.

Your client needs to pay money into the company to avoid the BIK. If the loan exceeds £10k at any point in the year, he needs to pay an amount equal to the average balance (average of opening and closing balances) times the official rate to avoid tax on the BIK - it's not just on the excess over £10k. HMRC and the client have the right to opt for a daily calculation. Look up the detail in the 480 on gov.uk., Chapter 17 and appendix 6.

Look at Para 17.35 for how to deal with interest paid later than the year it's originally due.

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Replying to David Heaton:
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By tonycourt
15th Jun 2018 16:05

David, for the sake of clarity, do you agree that a debit for interest due from a director's loan account which is in credit (to keep it simple we'll assume he or she has only one loan account rather than say, one in credit and the other overdrawn) constitutes payment?

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Replying to tonycourt:
By SteveHa
15th Jun 2018 16:10

I assume in the circumstances that you are talking about a DLA that was in debit to the tune of a minimum of £10,000, and has been put into credit in the same year?

If so, then it has been put into credit by the introduction of funds, and so debiting those funds to satisfy the interest should work.

I'm not so sure it works if it's simply a credit of an unpaid dividend to the DLA which has put it into credit.

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Replying to SteveHa:
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By tonycourt
15th Jun 2018 16:30

Not quite.

There is a tricky point regarding the aggregation of loans which I was trying to dodge round. But if you follow HMRC's approach to separate loan accounts (which largely I agree with, i.e. broadly that each account is separate if recorded separately in the company records) a debit for the interest from a loan account which at the time had sufficient credit to cover the charge would be sufficient to constitute payment of interest. While this opens up the chance of some mischief, I assuming a plain vanilla situation where there's no attempt to artificially create separate loan accounts solely for the avoidance of tax.

On your second point. Naturally, any loan account can only be in credit if cash or assets are introduced.

On your third point - how can a dividend credited to a loan account be "unpaid"?

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Replying to tonycourt:
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By Tax Dragon
17th Jun 2018 08:58

Tony, I agree.

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Replying to tonycourt:
By SteveHa
18th Jun 2018 14:49

By "Unpaid" I simply meant a dividend credited to the DLA but not paid out in cash to the shareholder. I was trying to draw a difference between an "on paper" transaction, compared with an actual, this happened transaction.

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Replying to SteveHa:
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By tonycourt
18th Jun 2018 14:56

I follow - I thought you might mean that but just wanted to check. However, it makes no difference if the dividend has been distributed in cash or credited as a book entry, if it puts the loan account in credit a debit to cover interest would be OK for the purpose of making good the benefit in kind.

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By johngroganjga
15th Jun 2018 15:55

The £10,000 is a de minimis, not a tax free allowance.

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By Portia Nina Levin
18th Jun 2018 15:54

Oh look, an -ex horse that's suffered a severe beating.

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By Dib
19th Jun 2018 13:33

Welcome back - where have you been?

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By Portia Nina Levin
19th Jun 2018 14:12

I'm here every day. It's just that the content's so 5h1t I've been disinclined to comment.

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