Don’t circulate the directors’ loansby
HMRC has issued new guidance for directors who try to avoid the corporation tax charge on overdrawn loan accounts, by moving the loan, or repaying it with shares or assets.
Directors are often tempted to take funds from their own companies as loans. This can be tax efficient on a temporary basis, as the individual can have the use of funds for up to 21 months, without the company having to pay corporation tax on that money.
However, if the director’s loan account (DLA) is still overdrawn by the corporation tax payment date, a corporation tax charge is likely to arise under the loans to participators provisions (CTA 2010 ss. 455 – s 465). This charge is currently payable at 32.5% of the loan outstanding, and is paid alongside the main corporation tax liability for the year.
The s. 455 charge can be reclaimed on the corporation tax payment date that falls after the end of the accounting year in which overdrawn DLA is cleared.
Are all loans caught?
A loan to a director will not necessarily be caught by the loans to participator rules, but its best to start from the assumption that it is caught, and then check whether the exemptions in CTA 2010, s. 456 or s. 461 apply.
For example, the s. 455 charge does not apply if the company is not a ‘close’ company (see CTM 60105), but you also need to look at the group relationships if some of the companies in the group are ‘close’ and others are not.
A loan to a director can only be exempt from s. 455 charge (and related charges) if the director meets three conditions (CTA 2010, s 456):
- Works full time for the company or an associated company.
- Does not have a material interest in the company or in any associated companies.
- The loan, and all other loans that director has from the company, do not exceed £15,000.
To avoid the s. 455 charge the director may pay off the loan just before the charge becomes due, but if those funds come from another company in the group the first loan will not be treated as being repaid.
Sam owns all the shares in Alpha Ltd which in turn owns all of Beta Ltd. Sam has an overdrawn DLA with Alpha of £1m. Just before the section 455 charge bites, Sam borrows £1m from Beta and clears his loan from Alpha.
In a one year’s time, to avoid the section 455 charge due to be paid by Beta Ltd on his overdrawn DLA, Sam borrows a similar amount from Alpha, pays-off the Beta loan and so the debt circles round and round the group.
HMRC is clear that this circulation of the debt doesn’t avoid the s. 455 charge, as the substitution of a fresh debtor, for the original debtor, does not constitute repayment (CTM 61602), based on the case: Collins v Addies  65 TC 190 CA.
In this example the section 455 charge is payable by Alpha Ltd as the debt has not been repaid. If the debt has grown while held by Beta Ltd, then Beta will be due to pay the section 455 charge on the additional amount.
An alternative way to clear the DLA is for the director to transfer a personally owned asset to the company, but as this will be a connected party disposal the asset must be transferred at open market value.
Jo is the only shareholder of Gamma Ltd, and has an overdrawn DLA of £2m. Jo also owns shares in Delta Ltd which she claims are worth £2.5m. Jo transfers her Delta shares to Gamma and this transfer clears the overdrawn DLA.
However, HMRC discovers that the Delta shares are only worth £250,000. This means the overdrawn DLA was only reduced to £1.75m on the transfer of the Delta shares to Gamma, and a s. 455 charge is due (see CTM 61604).
Not completely tax free
Even if there is no s. 455 charge, there may be a benefit in kind income tax charge (ITEPA 2003 pt 3 chp 7), and an employer’s class 1A NIC charge payable on the benefit of receiving an interest-free, or low-interest loan (see EIM26102).
This benefit in kind charge is completely separate to the CTA 2010 s. 455 charge, but both can apply to the same loan.
The benefit in kind charge applies for each tax year in which the employee (directors will be employees for this purpose) holds a loan or loans from the employer of £10,000 or more. Income tax and class 1A NIC is payable on an amount of interest calculated at the official rate (currently 2%) on the loan, less any interest actually paid by the employee in respect of the loan.