05 Jul Borrowing money from your company?
On the face of it, it’s puzzling that there are any tax implications when one simply borrows money from a limited company. A loan, after all, isn’t income and, therefore, shouldn’t be subject to income tax; and it doesn’t consist of the proceeds of disposing of an asset and, therefore. shouldn’t be within a million miles of capital gains tax.
However, if you delve an inch below the surface of this sort of reasoning, you’ll see that there are tax implications of borrowing money, for the reason that it would otherwise be a straightforward and tax-efficient alternative to taking income from that company.
The principal tax charges
It is assumed, in what follows, that the situation we are looking at is the common one in practice of someone who is a shareholder and director of a close company, or closely associated with such a shareholder and director, taking a loan from that company’s resources. In this classic situation, you’re basically looking at two different tax charges:
- A charge on the company under the ‘loans to participators’ rules; and
- A charge to tax under the ‘beneficial loan’ income tax provisions.
To qualify as a loan chargeable under the ‘loans to participators’ provisions, the recipient needs to be a participator (as defined – most often, in practice, a shareholder) in the company, or associated with such a participator. Those associated with a participator, in summary, are close relatives, and trustees of trusts set up by the participator; just the sort of people, in short, that otherwise you might want the company to lend to, to avoid the tax charge.
The tax charge is now (following a recent hike in the rate) at an amount of 32.5% of the amount loaned. This has to be paid to HMRC if the loan is still outstanding nine months after the end of the accounting period in which it was made. It follows from this, of course, that the tax charge can be avoided if the loan is repaid to the company within this nine-month period. The rationale for the loans to participators charge (which is levied under CTA 2010, s 455) is clear; if a shareholder was tempted to take a loan from the company as an alternative to receiving a dividend, in order to save the income tax charge that would be levied on a dividend, HMRC want their tax anyway.
The beneficial loan charge, by contrast, is effectively levied on loans made to people in their capacity as employees of the company, rather than as shareholders. An interest-free or subsidised rate loan is taxed under the benefits-in-kind code of ITEPA 2003 based on the difference between the interest charged on the loan and the ‘official rate’. Therefore, if the loan is interest-free, the individual is treated for tax purposes as if he had received a benefit equal to the amount of the loan multiplied by the official rate (currently 2.5%). As a benefit-in-kind, this doesn’t just give rise to an income tax charge on the individual, but also to a charge to Class 1A National Insurance contributions on the employer.
Avoiding tax on beneficial loans
Looking at planning techniques for the income tax charge first, one simple way of avoiding the charge is to levy interest on the loan at the official rate (or more, if you choose). Even if this interest is rolled up in the loan, and not immediately paid, this would avoid the income tax charge on the individual and the National Insurance charge on the employer.
The drawback, of course, is fairly obvious; at some point, it will be necessary for the amount actually to be paid. Unless you are looking at a very long-term ‘end game’, with the loan being repaid on (say) the sale or winding-up of the company, it is likely that you would have to take taxable income from the company in order to make the repayment. If this were the case, clearly the charging of interest would constitute no more than a deferral, rather than a permanent saving of tax.
The loans to participators tax charge
This is a very strange form of tax charge, in fact, because it certainly isn’t income tax, and it isn’t really corporation tax either. Indeed, it is what you might refer to as sui generis. In some ways, it’s more like a deposit with HMRC, refundable when the loan is repaid, rather than a permanent tax charge. Interestingly, from the tax planning point of view, the tax is charged on the company itself, rather than on the individual, even though it is clearly a kind of substitute for the income tax that the individual would have paid if he had taken a dividend instead of a loan.
First of all, let’s consider a possible ‘get out’ from the section 455 tax charge. This tax charge does not arise where the loan is made by the company in the course of a trade of money lending carried on by it. On the face of it, this would seem to be a defence which could be raised quite often because the company could easily argue that any loan it makes to its participators constitutes a money lending trade – provided a commercial rate of interest was charged on the loan. However, HMRC will tend to resist this argument in practice unless the company is clearly a professional money lender, complying with the stringent requirements for the professional providers of credit these days.
Another approach to take to the section 455 charge, however, would be to say that it may well be more favourable in its results than taking a dividend, even despite the section 455 tax charge.
Example 1: Dividend or section 455 charge
Consider the position of Ms A, who is a top rate income taxpayer, but wants to take enough money from her company to repay a personal loan of £100,000. If she takes the money as a dividend, the top rate of income tax would ensure that she would need to take a dividend of approximately £160,000 to be left with sufficient money, post tax, to repay the £100,000 loan. If, instead, Ms A takes a loan from the company, the amount of money the company has to put up is only £132,500, being the £100,000 loan to Ms A plus £32,500 in section 455 tax.
Because of the generally undesirable tax effects of taking loans from your own company in this way, you could consider methods of repaying the loan which perhaps fell short of actually putting your hand in your pocket.
For example, if you have an asset like a car, a property, or even intangible assets like rights to the computer software, these could be transferred to the company by way of an effective repayment in kind, thus avoiding or repaying the loan.
The section 459 ‘trap’
Finally, bear in mind that a loans to participators tax charge can apply in cases which are not obvious. Section 459 of the same Act is clearly aimed at situations where the taxpayer is attempting to manipulate the facts artificially to avoid a tax charge: nevertheless, it can apply in ‘innocent’ situations as well. The best way to illustrate this is by an example.
Example 2: Section 459 charge
Mr X is a participator in two companies, Y Limited and Z Limited. He has a director’s current account balance in his favour in Z Limited of £100,000, which he would like to draw down. Unfortunately, Z Limited has no money, and the £100,000 he would like to get his hands on is actually sitting in the balance sheet of Y Limited.
Mr X, therefore, arranges for Y Limited to lend the £100,000 intercompany to Z Limited, which then repays the £100,000 director’s loan it owes him. This is caught by section 459, and £32,500 tax would, therefore, fall due.
Interestingly, it appears that this would not be the case if there was simply a transfer of credit balance between the companies, with Z Limited transferring the liability under the director’s loan account to Y Limited in return for an intercompany balance. Y Limited could then pay the £100,000 to Mr X direct, and this would not appear to give rise to a loans to participators tax charge.