Tax on loans to participators

By Mike Chapman, Knill James Tax Partner

In this blog, Tax Partner Mike Chapman looksat the rules on loans to participators and the tax charges that can arise in order to prevent companies from making funds available to participators free of tax.

Overview

It is generally well known that a charge to tax can arise where a 'close' company makes a loan or advances money to a 'participator'. The rules also cover overdrawn directors' current accounts, known as a '455' charge, under provisions contained within section 455 of Corporation Tax Act 2010.

Loans or advances can be excluded where they relate to goods or services supplied in the ordinary course of business, on regular terms, with a maximum of six months' credit.

Close companies

What comprises a close company can be complex but in essence is broadly one that is under the control of a small number of persons who can direct its affairs. Normally this is taken as five or fewer participators or directors who are also participators, when there is no minimum number for the company to be regarded as close.

There are a number of exemptions from close company status, for example the rules cannot apply to a non-resident company trading in the UK through a branch or agency.

Participators

A participator in a close company is any person having a share or interest in the company. In the majority of cases this will be the shareholders but can also include persons with voting rights, loan creditors and those entitled to acquire a right to participate in distributions of the company.

When considering whether a company is close or not and whether a 455 charge arises, the rights of 'associates' of participators must be aggregated with those of the participator. Most commonly associates will be relatives but can also include partners of the participator in any partnership. The term relative includes only immediate or lineal relatives, specifically:

• Spouses or civil partners
• Parents or remoter forebears
• Children or remoter issue
• Siblings

The 455 charge

Having established whether the company is close, the loans or advances to participators will fall into charge if they remain outstanding more than nine months after the end of the accounting period in which the loan is made. The charge is calculated according to the dividend upper rate for the tax year (not accounting year) in which the loan is made. For loans made after 6 April 2022, the rate is 33.75%.

The normal due date for payment of the tax is nine months and one day after the end of the accounting period of the loan, which for most companies is the same date as corporation tax on profits is due. Details of any unpaid loans should be returned on the supplementary pages CT600A as part of the company's corporation tax return.

Reclaiming 455 tax

Although 455 tax is returned and paid in parallel to a company's corporation tax liability, it differs in that it is a temporary charge, repayable to the company when the participator loan is cleared. The mechanism for repayment however falls outside of the Corporation Tax Self Assessment (CTSA) regime and must be claimed through filing of form L2P. The procedure is described on the HMRC website:

https://www.gov.uk/government/publications/corporation-tax-reclaim-tax-paid-by-close-companies-on-loans-to-participators-l2p

As the L2P process falls outside CTSA, it is particularly important that opportunities to reclaim are not missed and companies' and agents' record keeping needs to keep abreast of loan movements in this respect. Claims for repayment must be made within four years of the end of the accounting period in which repayment of the loan takes place. It is also important to note that HMRC will reject any L2P claim made less than nine months after the end of the accounting period of the loan repayment, even if the company's CT return is filed earlier.

Replacement of loans and netting-off

Most loans or overdrawn directors' current accounts are generally repaid by direct injection of funds or by the declaration of a dividend. In order to prevent the practice of temporary repayment of loans just before the nine-month deadline followed by loan replacement thereafter, anti-avoidance rules have been introduced to counter such 'bed-and-breakfasting' arrangements.

Additionally, companies have sought to argue that where a participator has both debit and credit account balances in a close company or in separate close companies, that these can be aggregated to reduce or obviate any charge. HMRC explain their view on aggregating accounts in their manuals at the link below:

https://www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm61565

HMRC generally do not accept that separate accounts can be aggregated or netted off, though they do state that credit balances can be used to repay a debit balance provided that relevant book entries are made.

In practice, even if the relevant book entries have been made, in order to obtain a level of comfort over the 455 position there should be additional evidence to support the assertion. This could take the form of minutes or formal written agreements between the companies involved.

The dates that book entries take place will be important as HMRC state that for the purposes of 455 charges, the date of repayment is the date the book entries are physically made so simply making an audit adjustment without a corresponding entry in the relevant company's books and records will not suffice as evidence of repayment.

In summary

Establishing in the first place whether a company is close and who the participators are can be complex, even before getting to grips with the tax administration of 455 charges.

It should also be remembered that where 455 is in point, it is likely that there will be income tax consequences in relation to beneficial loan arrangements, which are outside the scope of this commentary.

Also outside the scope of this blog are loans which are treated as participator loans though made indirectly, so called 459 charges, which can trap the unwary in certain circumstances.

Here to help

If you have any questions or would like more detailed advice on any aspect of participator loans, please contact Mike Chapman on 01273 484913 or mike@knilljames.co.uk