One of the many ways to extract cash from your family company is for the company to lend you money. This can be a useful source of short-term finance and, used wisely, can be tax-effective. However, tax charges may arise on the company if the loan is not repaid by the time that the corporation tax for the period is due.
From a company’s point of view, where the company is a close company, if it lends money to a shareholder (or to an associate of a shareholder, such as a spouse or civil partner) and all or part of the loan has not been paid back within nine months and one day of the end of the accounting period in which the loan was made, there is a tax charge on the company on the amount of the loan outstanding at that date. (This is known as a section 455 charge.) Section 455 tax is charged at the rate of 25% where the loan was made before 6 April 2016 and at 32.5% where the loan was made on or after 6 April 2016. The rate at which section 455 tax is charged is linked to the higher rate of dividend tax.
When the loan is repaid (or, as we shall see below, written off), any section 455 tax paid previously is repayable to the company, but not until nine months and one day after the end of the accounting period in which the loan was repaid or written off.
For example, if a company makes its accounts up to 31 December each year, and in May 2016 it lends a shareholder £10,000, then unless the loan has been repaid by 1 October 2017, the company has to pay section 455 tax of £3,250 (£10,000 @ 32.5%) on that date. If the loan is repaid before 1 January 2018, then the £3,250 tax will be repayable on or after 1 October 2018 – normally by offset against the company’s corporation tax liability for the year to 31 December 2017, due by that date.
One way to avoid incurring a section 455 tax charge is for the company to write off the loan within the nine months after the end of the accounting period in which the loan was made. Note, however, that the company cannot claim a tax deduction for the amount written off, as it could with a normal bad debt, and that the shareholder would be taxed on the amount written off. Paying the section 455 tax, and clearing the loan at a later date, may be preferable.
From the point of view of the shareholder, there are two tax charges on having a loan from the company. If the shareholder (or a relative) is an employee or director of the company, and the loans to him and to his associates total more than £10,000 at any time in the year, unless he pays the company interest at the ‘official rate’, set at 2.5% from 6 April 2017, the shareholder is taxable on a benefit in kind valued at 2.5% of the loan – and the company also has to pay Class 1A National Insurance on the same amount. If an interest-free loan of £12,000 is outstanding for the whole of the 2017/18 tax year, the employee would be taxed on a benefit of £300 (£12,000 @ 2.5%) meaning that the employee or director would pay tax of £120 if he pays income tax at 40%. There is no employee NICs to pay, but the company would pay Class 1A NIC of £41.40 (£300 @ 13.8%). If the employee pays the £360 interest to the company during the tax year, then no benefit is charged on him or the company. However, it is cheaper to pay the tax and the Class 1A (which in the case of a higher rate taxpayer total £161.40) than to pay the interest of £300 on the loan. As a result, it can be much cheaper to borrow from the company if it has the funds available, than from a bank or other commercial lender, or to pay interest on a credit card.
If the company writes off the loan, then from the director’s point of view (assuming he is also a shareholder), he is treated as if the company had paid him a dividend of the amount written off. This means, for example, if our loan of £12,000 is written off in 2017/18, the amount of tax payable would depend on whether the dividend allowance was available and on the taxpayer’s marginal rate of tax. Assuming that the taxpayer was a higher rate taxpayer, tax of £3,900 (£12,000 @ 32.5%) is payable if the dividend allowance has already been used, and of £2,275 if the dividend allowance is still available (£7,000 (£12,000 - £5,000) @ 32.5%).
However, depending on the circumstances and the taxpayers marginal rate of tax, it may be preferable to leave the loan (or so much of it as exceeds the available dividend allowance) outstanding and pay the section 455 tax. The tax payable on writing off the loan is lost for good and cannot be recovered, whereas any section 455 tax could potentially be recovered at a later date if the loan is either repaid or cleared by dividend payments within future allowances.
Section 455 tax is payable at a rate of 32.5% -- the same rate payable on dividends where they fall within the higher rate band. Where dividends fall within the basic rate band, they are taxed at 7.5%. If the taxpayer is a basic rate taxpayer, it may be beneficial to write off so much of the loan (once dividend allowance has been used up) so as to utilise the remaining basic rate band. However, where the liability would be at the higher rate, it may be preferable to leave the loan outstanding and pay the section 455 tax with a view to writing it off at a time when the dividend allowance is available or when a dividend would be taxable at the ordinary dividend rate. Again, the optimum position will depend on individual circumstances and there is no substitute for crunching the numbers.
The position for NIC is less clear. HMRC will argue that the writing off of the loan is ‘earnings’ from employment and so subject to NIC. A good argument against this (based on the tax case of Stewart Fraser Ltd v HMRC in 2010) is if the loan was written off as a result of a shareholder’s resolution. This is a very complex matter and you should take expert tax advice before using this technique.
Unlike dividends, the amount lent to the shareholder need not depend on the proportion of the company’s shares he holds, and the company does not need to have distributable profits to cover the amount written off.
Lending money to a shareholder can be a useful way of using company money as it is possible to borrow up to £10,000 for up to 21 months’ tax and NIC-free, which is much cheaper and easier to arrange than a bank loan. But there are many traps for the unwary, and expert tax advice is needed if you are going to use loans to extract funds from the company. It should also be noted that there are anti-avoidance provisions to prevent loans being repaid and the funds re-borrowed to avoid a section 455 tax charge.
This is a sample extract from the report Tax Efficient Ways To Extract Cash From Your Company, published by TaxInsider.co.uk.