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Juliana Watterston, MsC FCA, CTA (Fellow) explores the rules and implications of ICTA 1988, s 419.
Loans to participators
Close companies must self-assess tax liabilities in respect of any loans not in the ordinary course of business to participators or associates, which can result in the requirement to make tax payments to HMRC equal to 25% of the outstanding loan or advance made during the accounting period. The tax need not be paid if the loan has been repaid, released or written off within nine months and one day following the end of the accounting period. Where the loan or advance is repaid, released or written off more than nine months after the end of an accounting period, the tax paid can be repaid nine months after the end of the accounting period in which the repayment, release, etc takes place. The company should make use of supplementary page CT600A (loans to particpators by close companies) to report details of the loan to HMRC when submitting its company tax return (ICTA 1988, s 419).
Loans to participators or their associates made during the accounting period must be disclosed on the corporation tax return. Supplementary pages CT600A is used for this purpose. Details of the name of the participator or associate to whom the loan was made and the amount of the loan outstanding at the end of the accounting period for which the return has been made must be disclosed in Part 1.
The effect of completion of both Parts 1 and 2 will result in no liability to s 419 tax at 25%. The practical implication is that HMRC will now have been informed of the amounts loaned to the participators and the associates and will be able to follow through the beneficial loan declarations on form P11D for directors, other employed participators and their associates. A benefit in kind may arise on the employee or director concerned in respect of direct loans. A benefit in kind may also arise on the employee loans made to their associates.
If the loan has been repaid, released or written off later than nine months and one day after the end of the accounting period, details of the name of the participator or associate whose loan has been repaid released or written off together with the amount and date repaid, released or written off must be disclosed in Part 3. It follows that if the loan has not been repaid, released or written off at all then neither Part 2 nor Part 3 can be completed. The effect of completion of Part 3 or non-completion of Parts 2 and 3 is that the s 419 liability will be shown in Box A13. This amount should be shown on Box 79 on CT600 (the corporation tax self-assessment return for the year). Corporation tax software and online filing will automatically make these calculations but manual completion following the step by step instructions on form CT600A should arrive at this result The tax at 25% of the outstanding loan then becomes payable with the main corporation tax. Any late payment falls within the normal interest provisions (TMA 1970, s 109). HMRC may make enquiries into the loan accounts as part of their corporation tax self-assessment enquiries.
Loans within s 419(1)
To be within s 419(1) the loan must have been made ‘otherwise than in the ordinary course of a business carried on by it which includes the lending of money’. The principle of the lending of money was tested in Brennan v Denby Investment Co Ltd (2001) 73 TC 455 and resulted in the comment that ‘business requires some regularity of occurrence’. It would seem that without doubt a commercial lending bank’s business includes lending money. HMRC state that they will look at the following characteristics to determine whether there is a money lending trade:
If indeed there is a money lending business the loan to the participator must be made to the participator on the same commercial lending terms (HMRC Company Taxation Manual CTM 61520).
Loans to employee share schemes and employee benefit trusts are within s 419. Section 419(1) is applied at the time of the loan, if the trust is a shareholder or individual trustees are participators in the company. HMRC state that ICTA 1988, s 419(5) may apply when the trustees make payments to existing shareholders for their shares (HMRC Company Taxation Manual CTM 61525).
HMRC state that they will not apply s 419 where money is lent to a partnership of which the company is a member where there is a genuine partnership with bona fide arrangements. However, HMRC may invoke s 419(5). This section enables HMTC to assess a loan not made by the close company but by arrangements not in the ordinary course of business to s 419(1) (HMRC Company Taxation Manual CTM 61515).
Loans not within s 419(1)
Not only are loans and advances that a company makes to its participators and/or their associates, other than in the ordinary course of business, within s 419(1), but also:
As regards debts due to a third party, HMRC acknowledge that a debt can only be assigned by the third party. If the debtor (the person to whom the money is lent) and the close company of which he is a participator agree that the close company will pay the debt on his behalf, ICTA 1988, s 419(2)(b) cannot apply. However, a debt due from the participator to the close company may arise when the close company pays the debt to the third party on the participator’s behalf, which will fall under ICTA 1988, s 419(2)(a). Indeed depending on the facts of the case HMRC may treat the amount as remuneration or a distribution (HMRC Company Taxation Manual CTM 61535).
As regards the provision of goods or services, HMRC acknowledge that a credit period runs from the time that goods are delivered or services are performed until time of payment (Grant (Andrew) Services Ltd v Watton (1999) 71 TC 333,  STC 330 (HMRC Company Taxation Manual CTM 61535).
Section 419 does not apply to loans less than £15,000, where the borrower is a full-time working director or employee of the close company or of an associated company with no material interest in the company (ICTA 1988, s 420(2)). No material interest means 5% or less direct or indirect control (associates included) of the ordinary share capital or the assets in winding-up (ITEPA 2003, s 68). HMRC interpret full-time as not less than three-quarters of the normal working hours of the close company (HMRC Company Taxation Manual CTM 61540). As soon as the conditions of s 420(2) are no longer met, for example, by the borrower acquiring an interest of more than 5% then s 419 will apply from that time. Spouses and civil partners if employees of the company have their own £15,000 limit.
For accounts purposes if a loan is made to a participator the company will record the loan in it its nominal ledger as a ‘loan account’. Director loan accounts are a common feature of owner-managed companies, which are invariably close companies. HMRC will not concur to the netting off of one loan account against another unless there is a genuine joint loan, for example, as between spouses, where a joint nominal ledger loan account would be operated. A participator or director may have more than one nominal ledger loan account with the company, where loans carrying different terms are recorded. The fact that one loan account may be in debit and another in credit has no avail with HMRC. This is because HMRC treat all loan accounts as separate loans. If a genuine posting is made to clear the two loan accounts then this is treated as though the loan had been repaid under ICTA 1988, s 419(4). The posting date is the repayment date (HMRC Company Taxation Manual CTM 61550).
Actual repayment by the participator or a third party takes place on the date that payment is made. A director’s loan account may be cleared by a bonus payment. ITEPA 2003, s18 onwards determines the date that the bonus is received by the director for income tax purposes (see Tottel’s Income Tax 2006-07 para …..). For s 419 purposes the date of repayment is the date that the bonuses are voted or the date on which PAYE was operated if earlier (HMRC Company Taxation Manual CTM 61605).
The director/participator may wish to use a dividend payment to clear the loan account. In practice, the company’s articles should be examined for any matters that may affect dividend payments. If, following Table A, final dividends may be declared by the company in general meeting (Article 102 Table A 1985 Regulations) and interim dividends may be paid by directors from time to time (Article 103 Table A 1985 Regulations). A dividend may only be declared if there are sufficient net realized profits. For accounts purposes a final dividend is due and payable on the date that it is declared. An interim dividend is due when paid.
A dividend is paid when it is due and payable (ICTA 1988, s 834(3)) but for s 419(4) purposes s 834(3) does not apply and until the dividend is paid the debt remains outstanding to the company (HMRC Company Taxation Manual CTM 61605). ‘A dividend is not paid and there is no distribution, unless and until the shareholder receives money or the distribution is otherwise unreservedly put at their disposal, perhaps by being credited to a loan account on which the shareholder has the power to draw’ (HMRC Company Taxation Manual CTM 20095). Evidence of the payment or credit should be shown in the company’s books of account.
HMRC acknowledge that in many small private companies the directors and shareholders are one and the same, and dividends are often credited to the directors/shareholders’ account with the company. In the case of a final dividend the dividend is ‘due and payable’ on the date of the resolution unless some future date for payment is specified. An interim dividend is only paid when the money is placed unreservedly at the disposal of the directors/shareholders as part of their current accounts with the company. So, payment is not made until such a right to draw on the dividend exists (presumably) when the appropriate entries are made in the company’s books.
If, as may happen with a small company, such entries are not made until the annual audit, and this takes place after the end of the accounting period in which the directors resolved that an interim dividend be paid, then the ‘due and payable’ date is in the later rather than the earlier accounting period.
A director may clear the account shortly before the year end by borrowing from an external third party shortly before the year end only to reinstate the loan at the beginning of the accounting period. HMRC will regard the company as submitting a negligent or fraudulent return under FA 1998, Sch 18, para 20 (HMRC Enquiry Manual EM 8565).
Section 419 tax repayment
When the loan is actually repaid the company will be due the s 419 tax that it has already paid. There is no facility for setting the repayable overpaid s 419 tax against the corporation tax liability for the year in which the repayment is made. The company will need to complete an amended Part 3 CT600A for the accounting period in which the loan was made. If the loan is repaid in time to enable the amended CT600A to be completed and submitted within the 12-month enquiry period, this will act as an amended return and repayment will be issued. Alternatively, if submission is outside the enquiry period, the revised form will act as a separate claim under TMA 1970, Sch 1A.
Section 419 loan released
If the loan is released or written off, the same procedures apply to the company as for repayment but the individual participator will be treated as receiving a distribution net of the 10% tax credit (ICTA 1988, s 421).
Circuitous and indirect loans
Circuitous and indirect loans are also caught by s 419. In particular, HMRC quote the situation whereby, for example, a close company makes a loan to an employee who is not a participator and that employee applies the loan in purchase of the shares from an existing shareholder. The existing shareholder is a ‘deemed borrower’ under ICTA 1988, s 419(5) and s 419(1) can apply (HMRC Company Taxation Manual CTM 61540).
This is because s 419(5) catches the situation where a close company makes a loan but no s 419(1) liability arises. A third party then makes a payment or transfers property to a participator or releases a participator’s debt. HMRC give the following examples:
Company D is a close company. Instead of making a loan directly to D, an individual participator, it makes it to an associated company, Company E. Company E then passes the loan to D. The loan by one company to the other is treated as if it had been made direct to D.
Company T, a close company, makes a loan to A. A is an individual participator in Company W but not in Company T. Company W, acting in concert with Company T, then makes a loan to D, an individual participator in Company T. Company T and Company W have swapped loans to participators and are treated as if they had made loans to their own participators.
Such loans should be assessed to s 419(1) in the normal way except where the amounts form assessable income receipts for the individual concerned (HMRC Company Taxation Manual 61670 and 61680).
TA 1988, s 422 (extension of s 419 to loans by companies controlled by close companies) is an anti-avoidance clause. A loan to a participator by a third party, directly or indirectly financed by the participator’s close company, is within s 419(1) by virtue of TA 1988, s 422. In addition, a loan to a participator by a company controlled by a close company is also within s 419(1).
Juliana Watterston, MsC FCA, CTA (Fellow) is author of ‘Tottel’s Corporation Tax Annual 2006-07’, from which the above article is extracted. The book is one of ‘Tottel’s Core Tax Annuals 2006-07’. The series is due to be launched in September 2006. Each of the new Core Tax Annuals costs just £19.95, or all six cost just £99.50! The Core Set comprises:
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Article Added Saturday, 21 April 2007 | 20469 Hits
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