The net tightens on moving money
It is a relatively common practice for close companies, generally speaking, companies that are controlled by five or fewer people, to lend money to participators / shareholders or associates such as family members. In most cases loans are granted for specific purposes, but the system is open to abuse: if a company were to lend money to an individual for an indefinite period, they would in effect be receiving broadly tax-free income.
To prevent this form of tax avoidance, current rules state that any loan to a participator that remains outstanding for more than nine months after the end of the accounting period in which the advance was made results in a corporate tax charge. Known as a ‘section 455′ charge, the company incurs corporation tax at a rate of 25% of the outstanding loan. This can be a substantial charge, but if the loan is subsequently repaid, the company is entitled to a refund of the tax paid.
However, the government is concerned that the current regulations contain several loopholes, and in this year’s Budget included draft legislation to address potential avoidance of the section 455 charge.
Three scenarios were outlined as potential loopholes which the government believes may be exploited. The draft legislation is detailed and complex, but in simple terms any loans in existence after 20 March 2013 under any of the following scenarios are likely to fall under the new legislation:
Loans via intermediaries
The new rules will apply where a loan from a close company is made via an intermediary such as a partnership, a Limited Liability Partnership or a trust. HMRC is concerned that there have been instances where companies have avoided a tax charge by making loans to partnerships or trusts where a participator is either a partner or trustee respectively. As a result, the loan goes indirectly to the participator, and the company avoids paying the corporation tax that would have been due had the loan passed directly to the individual. It appears that employee benefit trusts will also be included in this legislation.
Transfers of value other than loans
The new rules are also designed to close a loophole where companies might seek to avoid tax by transferring value in a form that is not a loan. A typical situation would be where the company and a participator form a partnership and the company leaves its share of the profits in the partnership. If the participator subsequently draws down funds from the partnership, facilitated by the company’s undrawn profits, it would not technically be a company loan. The proposed legislation will seek to create a tax charge in arrangements where value is received directly or indirectly by an individual.
Bed and breakfasting
Another scenario where the government suspects that taxes are being avoided is where participators repay the loan shortly before the nine-month repayment date, only to re-draw the funds shortly afterwards. In response, new legislation will be introduced so that if a loan repayment of more than £5,000 is repaid to the close company and another loan, or transfer of value, is made within 30 days, the original tax charge will apply. The rules will also prevent refunds of previously paid tax on the same basis.
In addition to the 30-day rule, tax relief for a loan repayment will be denied if an amount of £15,000 or more is outstanding and at the time of repayment there are arrangements, or an intention, to redraw an amount either through a loan, advance or an extraction of value from the company.
In recent years the government has introduced extensive legislation to address the issue of disguised remuneration. The amount of regulation around this area is now extremely large and complex. At first glance, these newly announced changes appear to do little more than to tie up a few loopholes, but it also suggests that HMRC perceives there is a significant vein of lost tax revenue ready to be tapped.
The Chancellor has been very vocal in his intention to pursue large corporations and wealthy individuals who do not pay their fair share of tax. What changes like these show is that he also has his sights set on small companies. The individual sums may be small but the large number of small companies in the UK makes this a high priority for HMRC.
The main concern is that the regulations are now so complex that perfectly innocent arrangements could end up being caught in the new legislation. With the wide number of close companies which could be affected by these changes, the consequences could be significant. Owners of close companies should examine their loan arrangements, and any other transfers of value, and if necessary seek professional advice on the potential impact of the rule changes.
Article originally featured on SMEWeb.com.