When is a loan not a loan?

  • Posted by: Zubaria Zafar

When is a loan not a loan?

When a loan is taken out with a bank the repayment terms are usually confirmed in a formal loan arrangement. However, if you are a director of your own company and you withdraw monies that are not salary or dividends, then those payments are normally considered a loan even where no formal loan arrangement exists. A loan can even arise from using company funds for private expenses or because the company pays a personal bill on the director’s behalf. In the absence of special rules, it would be easy for directors to take loans from the company and not repay, allowing the director or family member to use the money tax-free, possibly indefinitely.

To counter this, the tax legislation imposes a charge on loans made to participators that remain outstanding nine months and one day after the end of the year unless an exception applies. The charge is linked to the dividend’s higher rate of tax (currently 33.75%) so HMRC effectively recovers from the company the tax that the director (or participator) would have paid had they received the outstanding loan as a dividend and paid tax at the higher dividend rate. The charge is repaid when the loan is cleared.

Small loans

Such loans are outside the scope of the charge but the following conditions must apply:

Condition A

The amount cannot exceed £15,000, either alone or taken together with any other outstanding loans and advances made by the company or by any of its associated companies. Loans to a spouse or civil partner are not considered, each having its own £15,000 limit.

Condition B

The borrower must work full-time for the company or any of its associated companies (full-time means at least three-quarters of the company’s normal working hours).

Condition C

The borrower does not have a material interest in the close company or any of its associates. If the borrower subsequently acquires a material interest when the whole or part of any loan is outstanding, the company is treated as making the loan of the amount outstanding when the material interest is acquired.

‘Material interest’ is where the person (with or without one or more associates) either:

  1. controls more than 5% of the ordinary share capital of the company; or
  2. possesses or is entitled to acquire such rights as would in the event of winding up of the company or in any other circumstance entitlement that person to receive more than 5% of the assets, which would then be available for distribution among participators.

Note: if the director has a material interest then all loans are caught – not just those over £15,000.

Exceptions

There are exceptions to the charge:

  • advances of up to £1,000 to cover future business expenses
  • if the company is in the business of lending money, no charge arises on a loan made in the ordinary course of business
  • where the director has lent money to their company, any subsequent withdrawal is first treated as a repayment of those funds
  • the charge does not apply to a debt relating to a supply of goods and services by the company in the ordinary course of its trade or business unless the credit period exceeds six months or is longer than that normally given to the company’s customers.

 

Partner Note: CTA 2010 s455; s456 (3) to (8); Corporation tax manual 61540