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Neither a (Close Company) borrower nor a lender be – Part one

Author

Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Lend me your ears

It was with surprise that I found out the above (mangled) quote was from Hamlet and not from the Merchant of Venice.

The article could have made much of Antonio’s melancholy at the beginning of the play. Not to mention the worsening of his situation as a rather lazy religious stereotype becomes rather keen to get his pound of flesh. Alas….poor Yorick (that’s definitely Hamlet).

What relevance does this have? It certainly shows I don’t know my Shakespeare and also that one should always check the facts.

What’s in a name?

So this article was supposed to be something about Close Companies and loans wasn’t it?

What is a close company? A close company is the term given to a company which is controlled by 5 or fewer shareholders or is controlled wholly by its Directors. Essentially, this is likely to include most SMEs and family businesses in the UK. The second part of this article discusses an interesting point in relation to non-UK Companies.

Double, double toil and trouble

For a period of 12-18 months before the election there was a witch hunt of which Matthew Hopkins himself would have been proud. That was the witch hunt over ‘tax avoidance’ led by our very own witch-finder general Margaret Hodge.

Anyone who has seen my (now trademarked) Tax Dodger’s Ducking Stool presentation will know that loans from such Companies came within the manic stare of this witch hunt. Sir Chris Hoy and Peter Mandelson were specific examples which made the press. How dare they have the temerity to borrow from their own Companies? Indeed, self-styled tax expert Richard Murphy (now self-styled Corbyn-omics expert) howled ““It’s just about impossible to think this is motivated by anything but tax avoidance.”

What a load of bobbins.

A dividend has its own legal implications and its own tax framework. A salary and a bonus has its own legal and tax framework. Guess what? A loan does as well. We will see what that framework is shortly. It will hopefully then be clear that taking a loan from an SME Company as a Director Shareholder is not avoidance by any kind of rationale definition of the term.

The short and long of it

There are personal tax consequences of making such a loan. As a Director is an employee for the purposes of the tax code then, unless he pays the official rate of interest on the loan, he will have a benefit in kind. This benefit is subject to tax.

So for instance, if one takes a loan of £100k, it is outstanding throughout the tax year, and pays the Director pays no interest then he will have a taxable benefit of £3,250. This is then subjected to tax at the person’s marginal rate of tax.

So this looks an efficient way of putting funds in to the hands of a Director Shareholder. Perhaps Mandy, the Prince of Darkness, was on to something?

Indeed, as a short term play it is not such a bad move. However, longer term, there are darker forces afoot in the shape of the dreaded s455 charge. The s455 is a quasi-corporation tax charge which applies to a loan that remains outstanding after the expiration of 9 months and 1 day following the end of the accounting period in which the loan is taken out. The charge is an eye popping 25%.

So, if XYZ Mining Limited has a 31 December year end and a Director takes a £80k on 30 September 2015 then, if the loan remains outstanding when October 2016 rolls around the Company will suffer a tax charge of 25%.

Seems penal, but is this the end of the world?

Let’s take the example of XYZ Mining again and suppose the Company pays tax at 20%. Therefore if there’s £100k of profit then there is £80k to make a loan. If the loan remains outstanding then the £20k quasi corporation tax charge will apply. This represents an effective rate of 40% on extraction. If no interest is paid on the loan then there will be a benefit levied on the interest foregone (currently 3.25%).

40% plus, say, another 3.25% taxed at the marginal rate is not that bad. However, as and when this loan is repaid (see below) then the corporation tax is repaid by HMRC. Therefore if one had the loan outstanding for ten years, then repaid the loan as part of retirement / sale of the business (qualifying for Entrepreneurs’ Relief??) then this would represent quite a good extraction route. One would need to take care in how this was undertaken.

In the second part of this article we will consider how a loan might be undone, the special status of non-UK companies and some other interesting (!) points in this area.

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