Over time, companies or associated companies may accumulate substantial cash reserves. Whilst funds are commonly extracted through salary, dividends or pension contributions, another possibility is to incorporate a second company and transfer funds using an intercompany loan.

How does it work?

The first company lends excess cash to the second company, usually for valid business purposes such as investment, property acquisition or a new business venture. Importantly, the loan must comply with the loan relationship and associated company (2023) rules.

Loan relationship rules

A company is party to a loan relationship where:

• it is a creditor or debtor in respect of a money debt; and
• the debt arises from a transaction for the lending of money.

As a result, most intercompany loans fall within the loan relationship regime.

Where the borrowing company pays interest:

• Lender company – the interest received is taxable as a loan relationship credit.
• Borrower company – the interest paid is generally deductible as a loan relationship debit, subject to the usual corporation tax restrictions.

An interest-free loan can still qualify as a loan relationship and many UK intercompany loans are structured on this basis.

Problems often arise where the borrower cannot repay the loan and the lender writes it off. In many cases where this happens, HMRC denies relief for the lender because the companies are connected.

What is an associated company?

Companies are associated where one company controls another, or where the same person or persons control both companies.

‘Control’ includes the ability to acquire more than 50% of:

• ordinary share capital;
• voting rights;
• distributable profits; or
• assets on a winding-up.

When determining control, the rights and interests of associates may also be attributed to an individual. Associates include spouses or civil partners, parents, grandparents, children, grandchildren, siblings, members of a business partnership in which the taxpayer is also a member, and in some cases trustees and settlors.

However, when HMRC attributes rights held by associates, the companies must usually also have ‘substantial commercial interdependence’. HMRC considers three main factors:

• Financial interdependence – e.g., intercompany loans or guarantees.
• Economic interdependence – where one company supports or depends upon the activities of another.
• Organisational interdependence – such as shared premises, equipment, staff or management.

Direct ownership by shareholders is always taken into account regardless of commercial interdependence.

Dormant companies are generally ignored for associated company purposes. Certain passive holding companies may also be excluded where their activities are limited to holding shares and receiving dividends.

Importantly, a company only needs to be associated for one day during an accounting period to count as an associate for that period.

Tax implications

The associated company rules can significantly affect corporation tax liabilities.

Companies with profits up to the small profits threshold pay corporation tax at 19%, while companies above the upper threshold pay tax at 25%, with marginal relief applying between the two limits. This impact of associated companies is that these profit thresholds are divided equally by the number of associated companies.

For example, where there are two associated companies, the standard upper limit of £250,000 is reduced to £125,000 for each company. As a result, companies can reach the 25% corporation tax rate much sooner so both companies are taxed at the same tax rate.

Corporation tax payment deadlines

Associated companies also affect corporation tax payment deadlines.

A company generally enters the quarterly instalment payment regime once it is regarded as ‘large’, (i.e., where taxable profits exceed £1.5 million). This threshold is divided by the number of associated companies at the end of the previous accounting period.

Consequently, companies may become ‘large companies’ and have to pay corporation tax by instalments within the accounting period rather than the usual nine months and one day after the year end, thus creating potential cash flow pressure.

However, companies are protected from the instalment regime where their corporation tax liability is less than £10,000.

Practical point

Intercompany loans should always be properly documented, especially between connected companies. With reference to associated companies, it is important to regularly review company structures and control arrangements.