Introduction »

Neither a lender nor a borrower be

Managing the budget deficit will be high on the economic political agenda with no doubt some consequential impact on taxation matters. Meanwhile in the micro economy, borrowings frequently arise between a company and its ‘director shareholders’. This article considers the overall taxation perspective for both lender and borrower beginning with the common situation of where loan advances are made from the company to the individual.

The company perspective

A tax charge arises where a loan advance (or an increase in a loan) made to a director shareholder during the accounting period remains outstanding nine months and one day after the accounting period end. The tax rate is 25% of the amount of the loan which existed at the accounting period end and which is still outstanding at the due date.

If the loan is repaid in full (or in part) in a later accounting period, this tax (or part thereof) will then be repaid nine months and one day after the end of that accounting period. For example, if a loan was repaid on the first day of a 12 month period ending 31 December 2010, the tax relating to that loan would not be due for repayment until 1 October 2011 – nearly two years after the repayment of the loan! If instead the repayment was made on the last day of that same accounting period on 31 December 2010, the tax refund would still be due on 1 October 2011.

What happens if the loan is written off?

From the company’s point of view, the loan write off is essentially a bad debt for accounts purposes and is initially treated as an expense in the profit and loss account. But is it deductible for corporation tax? Such a bad debt has never been allowed as a trade deduction for tax purposes, but in recent years some have argued that a claim could be made for it to be relieved as a non trade debt under company loan relationship rules. There has always been a risk of HMRC challenge associated with this course of action but in any case this ‘loophole’ was closed by the Chancellor on 24 March 2010 in a Budget announcement now reflected in the Finance Act 2010. Essentially there is no corporate tax deduction for shareholder loan releases or write offs made on or after 24 March 2010.

What tax implications will there be for the director shareholder?

Firstly, if loans generally exceed £5,000 at any time in the tax year and interest is either not charged or is charged at less than the official HMRC rate (currently 4%), a taxable benefit will arise. This is generally calculated on an average basis, using average capital outstanding during the tax year and the average interest rate prevailing. Where there is significant fluctuation in loan balances and/or HMRC interest rates then an actual basis (amounts and rates) may apply instead. Whatever the resulting benefit, this is then charged to income tax at 20%, 40% or 50%, depending on the circumstances of the individual. The company as employer (but not the employee) will have to pay 12.8% national insurance contributions (NIC) on the employment benefit.

There is no taxable benefit if interest is charged at the official rate or for certain qualifying loans. There is also an exemption where non qualifying loans do not exceed £5,000 at any time in the tax year.

And a loan write off?

If a loan is written off, a director shareholder is assessed on the income as dividend income, as opposed to earned income. The total taxable income includes the amount written off grossed up for the 10% dividend tax credit available on all dividends. This is then charged at either 10%, 32.5% or 42.5%, depending on the individual’s circumstances. The associated 10% tax credit, (though non refundable) is available to reduce any tax liability.

Although from a tax view point the income is not assessed as earned income, it is generally considered to be subject to Class 1 employer and employee NIC.

Company as borrower

Of course, it may be that a loan account is not actually overdrawn, and the company actually owes money to the director shareholder. Clients who find themselves in this position can use it to extract money from the company in a tax efficient way.

From the director shareholder’s point of view, there is no reason not to charge interest on the amount lent to the company. If the company was borrowing the money from any other source, it certainly would have to pay interest. Commercial interest will generally be tax deductible for the company.

In the hands of the director shareholder, the income will be taxable as savings income, and will usually be taxed at 20%, 40% or 50%, depending on their individual circumstances. Exceptionally where an individual has less than £2,440 of other income (excluding dividends), some taxable savings income, may only be subject to a rate of 10%. Also, no NIC will be due as this only applies to earned income. This will benefit both employer and employee.

Introduction »