New rules for taxation of director's loans
Most small companies will be regarded as “Close” companies for the purposes of corporation tax. These companies have traditionally rewarded the owner managers (referred to as “Participators” in tax legislation) by a mixture of dividends and salary.
Any salary will inevitably incur a PAYE and national insurance charge and dividends may result in an end of year higher rate tax assessment for the individual.
On the odd occasion, the participator may deliberately or accidentally dip into the company bank account to pay for some personal expenses. In even more extreme situations, the participator pays scant regard to any formality and treats the company funds as his own.
In either case, once the end of year accounts are prepared it was often discovered that the participator owes a debt to the company.
Until March 2013 the rules were that unless the loan was repaid within nine months and one day of the financial year end then the company (not the individual) would be liable to pay tax equivalent to 25% of the loan in the year (the s455 tax charge).
Some participators took advantage of this nine month, one day rule, by paying sufficient funds back into the company before the deadline, only to draw it back out again shortly afterwards. In this way, they could effectively extract cash from the company for long periods without the necessity to pay any tax or NIC.
HMRC always frowned upon this practice but were powerless to stop it and consequently it became common practice amongst small businesses.
However, with effect from 1st April 2013 two specific legislative powers were introduced to stop this “Bed and Breakfasting”.
Firstly, the “30 days rule” – so that if, within any period of 30 consecutive days:
- £5,000 or more is repaid to the company in respect of amounts that have generated the s455 tax charge and
- New loans of £5,000 or more, are made by the company to a participator in a subsequent accounting period
Then the repayment at 1 is to be treated as a repayment of the later loan at 2 and not a repayment of the original loan.
Secondly, if the 30 day rule did not apply then relief for a repayment will still be denied if the total loan outstanding was £15,000 or more and at the time of the repayment there are any arrangements for further loans to be made to replace some or all of the amount repaid. In that case the repayment will be regarded as a repayment of the later loan and not a repayment of the original loan.
There is an important exception to both rules. The rules only apply if the amount repaid has not been subject to income tax in the hands of the participator. The most obvious exception therefore will be where a bonus or dividend is voted to the participator within nine months and one day of the year end and credited directly to the participators loan account.
It is clear that the new rules are complex and will catch out many, with penalty and interest implications. In our opinion, there is no substitute for proper professional advice.