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Subject to certain exceptions, where a ‘close’ company (see below) has made a loan, advance, or conferred a benefit on a participator or an associate of a participator, the company may be liable to an additional tax charge when paying their corporation tax (commonly referred to as ‘section 455 tax’).
Tax charge on the company
For most close companies, section 455 tax becomes payable if a loan or advance is not settled within nine months and one day following the end of the chargeable accounting period in which it is made. The rate of extra tax payable is equal to the higher-rate dividend tax on the outstanding loan at the due date for corporation tax. For loans made on or after 6 April 2022, the rate of tax payable on the outstanding amount is 33.75%.
A ’close’ company is broadly defined as a company that is controlled by five or fewer participators or any number of participators if the participators are also directors. A ‘participator’ is any person who has a share or interest in the capital of a company.
An ‘associate’ of a participator includes their relatives, partners in a partnership, the trustees of a trust a participator is involved with, and the personal representatives of a deceased estate where the participator holds an interest. A participator may also be an employee or director of the company, but this is not always the case.
HMRC’s Company Taxation Manual (at CTM61510) confirms that although the strict position of each and every advance, such as monthly drawings, could theoretically result in a section 455 tax charge, in practice HMRC usually only considers the year end position. However, in exceptional cases, HMRC can enforce the strict position.
The types of loans which are excluded from the section 455 tax charge are outside the scope of this article, and the commentary provided assumes that none of the exemptions apply to any of the scenarios given.
Beneficial loan rules
The rules relating to loans by companies are in place to prevent participators and their associates extracting money from the company and avoiding paying income tax on the payment, whilst maintaining the benefit of the money extracted. Where the loan is settled with the company within the time limits, no additional tax is payable by the company.
However, for the participator on whom the benefit is conferred, where interest is either not charged or is charged below the official rate by the company, a benefit-in-kind will need to be calculated, reported and taxed accordingly.
How the beneficial loan interest is treated and subsequently taxed depends on whether the participator is also an employee or director of the company. If they are, the benefit will be calculated and reported on form P11D, with the earnings being taxed as employment income. The company will also pay Class 1A National Insurance contributions (NICs) on the benefit provided.
When the participator is not a director or employee, the benefit is calculated in the same way; however, the value of the benefit is taxed as if it were a dividend. These rules exist to ensure that participators or their associates who are not employed or directors of the company do not avoid being taxed on the benefits provided.
Settlement of the loan
Where the outstanding loan is settled within nine months and one day from the end of the chargeable accounting period, no section 455 tax is payable by the company. Settlement can be made either by the loan being repaid or by being released or written off by the company.
Where the loan is repaid, there are restrictions which prevent repayment from being made and then money being loaned back again within a short period to avoid a section 455 tax charge. This process is known as ‘bed and breakfasting’. There are two provisions to be aware of in relation to the bed and breakfasting of loans, which may deem a repayment ineffective in reducing or eliminating a section 455 tax charge.
The mechanics of this rule apply when within any 30-day period:
- repayments totalling £5,000 or more are made either before or after the end of a chargeable accounting period; and
new loans totalling £5,000 or more are made after the end of that chargeable accounting period.
The arrangements rule applies where a subsequent withdrawal occurs outside the 30-day window as described previously. The arrangements rules apply when:
- prior to repayment, there is an outstanding loan of £15,000 or more;
at the time of repayment, there are arrangements in place to borrow a further £5,000 or more from the company.
The effects of these rules are to match the loan repayment with the subsequent withdrawal, such that the original loan is deemed not to have been repaid at all. If both rules are satisfied in relation to loan repayments, the 30-day rule takes priority.
Exception: Taxable credits
Where a repayment is made via a credit to the loan account, and the credit is itself taxable on the participator or associate, the bed and breakfasting rules do not apply. This would be the case if a credit is made via dividend or payment of salary, for example. A payment of rent would not satisfy this rule as the credit is not directly taxable and forms part of the recipients’ overall rental profits.
If a physical payment of the dividend or salary is made to the recipient, and the money is subsequently repaid to the company in satisfaction of the loan or advance, this does not satisfy the exemption criteria and the bed and breakfasting rules would still need to be applied.
Release or write off
Where the company either writes off or releases the participator or associate from their obligation to repay the loan, this will satisfy the conditions for either section 455 not becoming due (if done within the statutory time limits) or if already paid, enabling the company to obtain a refund.
In such circumstances, the participator or associate is treated as having received a dividend (or more accurately, a distribution), which will be taxed as income accordingly. This treatment is the same whether the participator or their associate is employed by the company or not. However, if they are also an employee, the loan release is treated as earnings for NICs purposes for both the company and the employee.
As a deemed distribution, the company will not be able to claim corporation tax relief on the release. If the loan had been repaid via a credit to the loan account of a bonus or salary through PAYE, this would be deductible for corporation tax purposes. However, the company can claim a corporation tax deduction for any Class 1 NICs it makes.
Obtaining a repayment
Where a loan has been repaid, released or written off, a company must make a claim for repayment of section 455 tax within four years from the end of the accounting period in which the loan was satisfied. A claim for relief from section 455 tax can be made either via the company tax return or by filing form LP2 with HMRC.
Where a company is due a repayment of section 455 tax and form LP2 is filed with HMRC, this should be done after the normal due date for payment of corporation tax for the accounting period in which the loan was repaid or released. In most cases, this will be nine months and one day after the end of the period.
When dealing with loans to participators, there are rules across several taxes which need to be considered and can easily be overlooked. An error in dealing with the appropriate returns due to HMRC can result in fines and interest for missed and incorrect returns. Care must be taken in dealing with the corporation tax, personal tax and employment tax issues associated with loans and advances.