Overdrawn directors’ loans to be hit by higher tax charges

Loans to participators

For many years there has been an anti-avoidance rule to prevent director shareholders avoiding tax by paying themselves via loans, which are never repaid, instead of taking dividends or salary. This rule applies if a company is “close” which is broadly one that’s controlled by five or fewer participators or under the control of any number of participators if they are all directors. If a close company lends money to a participator (normally a shareholder but could also include a loan creditor), any debt still owing after nine months from the end of the company’s financial year triggers a corporation tax charge (known as s.455 tax). Currently, the amount payable is equal to 25% of the loan owing. The company can then apply to get this tax back nine months from the year end in which the loan is repaid.

Tax rate hike

Buried in the Budget 2016 notes was an announcement that the s.455 tax rate is to increase to 32.5% with effect from 6 April 2016. The new rate will only apply to new loans made on or after 6 April 2016. If your client’s accounting period straddles 6 April 2016, different rates will need to be applied to the loans made before and on or after 6 April 2016.

Tip 1

If a director shareholder is looking to borrow a significant sum from the company which is unlikely to be repaid within nine months of their next year end, then you may want to advise them to do so before 6 April 2016 so the company will only pay 25% corporation tax on the loan.

Tip 2

Make sure the client’s accounting records make it clear which loans were made before 6 April 2016 and which were made on or after. Use this information to split the loan advances into before and after 6 April 2016 in your corporation tax computations.

The loan to participators tax rate will increase from 25% to 32.5% for loans taken out on or after 6 April 2016. If a director shareholder is looking to borrow a significant sum from the company and not pay it back within nine months of the next year end, then they should consider doing so before 6 April 2016.