Corporate Charges Set to Rise

Beware the pitfalls of overdrawn loan accounts

Budget 2016 announced that the corporate charge (s.455 charge) on loans to participators will rise from 25% to 32.5% as from 6th April 2016, so as to prevent an unfair tax advantage being obtained by taking a loan from the company rather than salary or a dividend. The new rate applies to loans, advances and arrangements made on or after 6th April 2016.

Loans (this includes overdrawn directors’ loan accounts) and advances to close company shareholders give rise to a tax charge on the company, unless the loan is:

• Made in the ordinary course of the company’s trade; or
• The loan (together with other outstanding loans to the borrower) does not exceed £15,000 and is made to full-time working directors or employees who do not own more than 5% of the share capital.

Any loans that do not fall within these exceptions must be reported by the company to HMRC not later than 12 months after the end of the accounting period in which the loan is made. Furthermore, the company must pay tax at 32.5% on the amount of the loan or overdrawn account balance nine months after the end of the accounting period in which the loan is made.
The tax is refunded by HMRC once the loan is repaid to the company and then only nine months after the end of the accounting period in which the loan repayment falls.

To avoid having to pay the tax completely therefore loans should be repaid to the company within nine months after the end of the accounting period in which the loan is made.

Example

The director of a PSC with an accounting year end of 31st December has an overdrawn loan account of £25,000 as at 31st December 2016. The director repays the loan on:

1. 25th September 2017
   Since this is before 1st October 2017, when the company is due to pay its corporation tax for the year ended 31st December 2016, the company will not have to pay tax at 32.5% on the loan.
2. 2nd October 2017
   Since the loan has not been repaid by 1st October 2017, the company must pay tax on that date at 32.5%, i.e. £8,125, and cannot claim repayment of the tax until 30th September 2018.

‘Bed and breakfasting’

When repaying their loans back to their company, contractors need to be aware of the anti-avoidance rules that counter a practice known as ‘bed and breakfasting’ and prevent a company escaping the 32.5% tax charge. This involves the shareholder repaying their loan either just before the company year end or within the nine month period following the end of the accounting period. Soon after however the shareholder might then withdraw a similar or greater amount from the company.

There are two scenarios where these rules apply:

30-day rule

If within a 30-day period, loan repayments of £5K or more are made to the company and this is followed by £5K or more being taken out of the company in an accounting period subsequent to the one in which the loan was made.

Arrangements rule

Where a loan is at least £15K and, at the time of repayment, arrangements are put in place by the individual for substitute loans to be made by the company of at least £5K and such monies are subsequently paid out at any time following the repayment.

‘Arrangements’ is not defined by HMRC and has a wide meaning.

Where either of these situations arise, then the repayment of the loan is treated as repaying the new loan rather than the old loan and the 32.5% tax charge will still apply. Where the amount repaid exceeds the amount of the new loans then any balance can be considered for relief from the charge.

The anti-avoidance rules do not apply where the repayment itself gives rise to a charge to income tax on the director/shareholder. This could happen, for example, where the loan is repaid by means of a dividend credited to the loan account which is included as income on the person’s tax return, or where a bonus is paid which is subjected to PAYE/NIC before being credited to the loan account.

Where money actually leaves the company, e.g the dividend or bonus is paid out in cash before being reintroduced into the company and credited to the loan account, then, regardless of whether income tax is chargeable on the dividend etc. when paid, this method will still be caught by the ‘bed and breakfasting’ rules.

Payment of rent from the company to the director/shareholder do not count either because HMRC consider this is not itself income that gives rise to a tax charge but rather it is a constituent part of the eventual calculation of profits from a rental business.