The ‘loans to participators’ provisions (CTA 2010, Pt 10, Ch 3) are relatively well-known among affected taxpayers, mostly being shareholders of family and owner-managed companies. The legislation broadly imposes a 32.5% tax charge on close companies in respect of loans or advances to participators.
As a general rule, this tax charge can be prevented in the above example of an overdrawn directors’ loan account to the extent that the ‘loan’ is repaid up to nine months after the end of the company’s accounting period in which it is made (CTA 2010, s 455(3)). There is also relief from tax charged if the loan is repaid or written off after that period (s 458).
‘Bed and breakfasting’
However, there are anti-avoidance rules to rules to block a practice commonly known as ‘bed and breakfasting’.
This practice involves the shareholder repaying the overdrawn loan account balance either just before the end of the accounting period or within the following nine months, so that the 32.5% tax charge (under CTA 2010, s 455) is not due. The shareholder might then withdraw a similar (or greater) amount from the company shortly thereafter.
If the anti-avoidance provisions (in CTA 2010, s 464C) apply, relief from the above tax charge is broadly denied (or withdrawn, if already given). The provisions can apply in the following circumstances:
- ’30 day’ rule – i.e. where, within any 30 day period, loan account repayment(s) of £5,000 or more are made to the close company, and a further amount of £5,000 or more is withdrawn by that person in an accounting period subsequent to the one in which the loan was made;
- ‘Arrangements rule’ – i.e. where a loan (e.g. overdrawn loan account) is at least £15,000, and at the time of the repayment there are arrangements for replacement withdrawal(s) by that person of at least £5,000, and the withdrawal(s) is subsequently made (at any time after the repayment). ‘Arrangements’ is considered to have a wide meaning in HMRC’s view (see its Company Taxation manual at CTM61635).
If ‘caught’ by either of the above rules, the effect is broadly that the repayment is treated as repaying the ‘new’ loan(s), rather than the earlier (‘old’) one(s). Relief from the 32.5% charge is therefore wholly or partly denied (or withdrawn) in respect of the ‘old’ loan(s) (i.e. relief will only be potentially available to the extent that the repayment exceeds the ‘new’ loan(s)).
Repayments not ‘caught’…
However, the above anti-avoidance rules do not generally apply if the directors’ loan account repayment (in the above example) gives rise to an income tax charge on the director shareholder (see below).
HMRC accept that repayments can be made via ‘book entries’ in the company’s accounting records, at the date when the book entries are made (see CTM61600).
…Or are they?
The most common ways for a director shareholder to repay an overdrawn directors’ loan account balance in a ‘taxable’ form is by crediting the loan account with their salary or a bonus from the company. Similarly, a dividend from the company may be credited to the loan account. Repayments by salary, bonus or dividend are generally considered to be exceptions from the ‘bed and breakfasting’ anti-avoidance rules. However, care is needed as to the date of ‘payment’ of the salary, bonus or dividend for these purposes.
Furthermore, it is important to note that if the salary, bonus or dividend is paid out in cash to the director shareholder, and is later reintroduced into the company and credited to the director’s loan account, this loan account repayment does not fall within the above exception to the anti-avoidance rules in HMRC’s view (see CTM61642).
A further word of warning: some types of repayment do not work for these purposes, at least according to HMRC. For example, if a director shareholder owns the business premises and charges the company rent, HMRC does not consider that the above anti-avoidance rule exception applies if the rents are credited to the loan account, on the basis that “this is not itself income that gives rise to a tax charge rather it is a constituent part of the eventual calculation of profits from a rental business.”
The above article was first published by Business Tax Insider (March 2016) (www.taxinsider.co.uk).