Family company caution - don't fall into a tax trap

Family companies that make loans to their shareholders face increased danger of falling into tax trap

For may years tax legislation imposed a tax charge on a family company (tax law uses the term “close company”) that makes a loan or advance to an individual who is a shareholder. The company’s tax liability is 25% of the amount of any loan caught by the rules if it is outstanding nine months after the end of the company’s accounting period in which it was made.

Before 20 March 2013, loans to certain trusts were not caught, and companies could avoid the tax by getting the individual to clear the loan before the nine month deadline only to replace it by a new loan. 

There was doubt as to how this tax applied to loans to partnerships: HMRC’s view was that a loan to any partnership that included a participator was caught, but some argued that no tax was due on loans to a partnership that had a corporate member.

As from 20 March 2013 the scope of the tax charge on a close company in respect of such loans has been widened, and new rules restrict the opportunities for repayment and replacement of loans.

  • The tax charge now applies to loans to certain partnerships, including LLPs, and trusts.
  • A new charging section now imposes tax on a close company that is involved in arrangements that result in a participator obtaining a benefit, whether directly or indirectly, in a way that avoids the existing tax charge (the tax payable by the company under this new charge is 25% of the benefit conferred).
  • New restrictions apply to the close company’s entitlement to claim repayment of the tax when loans are repaid.

The combined effect of this tightening up of the loan to participator rules and the PAYE real time reporting obligation forces family companies to take great care in recording and reporting their arrangements for making payment to individual participators.

Companies that transferred cash to participators before 20 March using a structure that did not trigger a tax charge under the pre-20 March rules may be able to leave these undisturbed and not suffer a tax charge.

The changes have implications for any closely controlled companies that have used structures seeking to avoid this tax charge, and for companies where anyone who is a participator is taking drawings during the year which are in the nature of a loan. 

These changes only affect the occasions a company has to pay tax on loans to shareholders.  The benefit in kind rules, which may apply to interest free or low interest rate loans from an employing company, are unchanged and remain fully applicable. .

The new rules add a layer of complexity to an already complicated area with traps for the unwary.