•‘Bed and breakfasting’ of loan repayments curtailed
•Loans by private companies to partnerships and trustees to be taxed
•A new charge on arrangements which ‘confer benefit’ to be imposed
As most readers will be aware, if a shareholder of a private company receives a loan from the company, the tax consequences are twofold:
•The company is liable to pay notional corporation tax (‘CT’) of 25% of any such debt outstanding at the company’s year-end which is not repaid within 9 months of the year end.
•If the shareholder is also an employee or director a benefit in kind may arise (though this is not discussed in this article).
Finance Bill 2013 proposes changes to the CT rules designed to prevent what HMRC sees as tax avoidance through ‘bed and breakfasting’ of loan repayments, loans certain partnerships and trustees and arrangements which ‘confer benefit’ in certain situations.
Bed and breakfasting
The purpose of the rules which apply to loans to ‘participators’ of ‘close’ companies (broadly meaning shareholders of private companies) is to deter companies from making loans to participators (who will usually also be the directors of the company) rather than paying remuneration or dividends.
‘Bed and breakfasting’ in this context refers to the repayment of a loan just before the end of the 9 month period to avoid payment of the notional CT charge, followed by a withdrawal of funds shortly thereafter. HM Revenue & Customs’ (‘HMRC’) existing guidance in its Company Tax Manual (www.hmrc.gov.uk/manuals/ctmanual/CTM61615.htmh) urges inspectors to look closely at such arrangements to ensure that actual repayment had been made and to consult with their technical specialists in some cases to consider whether tax avoidance case law may be invoked. However, such challenges have probably been rare in the past.
The new rules come into force on 20 March 2013 and restrict relief from the notional CT charge in two sets of circumstances:
1.Within any period of 30 days there are repayments of a loan totalling more than £5,000 and further withdrawals are made totalling more than £5,000.
2.The balance of the loan is £15,000 or more; a repayment is made following which a ‘new payment’ is made by the company; and either it was intended at the time of the repayment that the new payment would be made or ‘arrangements’ had been made for the new payment to be made.
To comprehend these rules it must be understood that the CT charge (under section 455 of the Corporation Tax Act 2010 (‘CTA 2010’)) arises at the point the loan or advance is made but no tax is payable (by virtue of CTA 2010, s 458) if the loan is repaid within 9 months after the company’s year end. Otherwise the tax is payable on the day following the end of the 9 month period and is then repayable 9 months after the end of the accounting period in which the loan is repaid or released.
Where the above circumstances apply relief will not be given under s 458 (or if given will be withdrawn) on the lesser of the amount repaid and the further withdrawal(s). There is another twist - this restriction does not apply to a loan repayment which is chargeable to income tax e.g. the crediting of a dividend. The effect of this is best illustrated by an example based upon HMRC’s Explanatory Note on the new rules.
Example 1 – ‘30 day rule’
Muggins Ltd is a private limited company whose accounting period ends on 31 March 2013 shortly before which Derek, a director and shareholder, borrows £15,000 from the company. On 1 December 2013 a dividend is declared of £9,000 and Derek repays the balance of £6,000. However, he draws further amounts from his loan account of £3,500 on 10 December 2013 and £2,000 on 15 December 2013.
The amount repaid is £15,000 but a dividend is not treated as a repayment and so for the purposes of the 30 day rule we are looking at a loan repayment of £6,000, which is more than the £5,000 de minimis limit. The 30 day period runs from 1 December to 30 December 2013 during which withdrawals totalling £5,500 have been made and so Circumstance 1 (see above) is met. The lesser of the two is the amount of the further withdrawals within the 30 day period. Relief is not given under s 458 on £5,500 and so notional CT of £1,375 is payable on 1 January 2014.
Example 2 - Arrangements
If the loan is £50,000 and Derek arranges a temporary overdraft to repay the loan on 31 December 2013 but then draws the funds out again on 1 February 2014, i.e. outside the 30 day period, it is likely that Circumstance 2 (see above) would apply. At the time when he repays his director’s loan Derek has made arrangements to draw a further sum in order to repay his overdraft.
Example 3 - Intentions
A similar example based on the HMRC Explanatory Note concerns repayment of the loan out of temporary funds. Suppose Derek has £50,000 cash available which he uses to repay his director’s loan on or before 31 December 2013 but he is due to make a mortgage repayment of £35,000 on 1 February 2014. He therefore withdraws £35,000 from the company on that date to make the mortgage repayment.
Since he must know that he will need £35,000 for his mortgage when he repays his director’s loan he must have an intention to redraw those funds and so, again, Circumstance 2 would apply. Relief under s 458 would not be given for £35,000 being the lower of the amount repaid and the further withdrawal. Notional CT of £8,750 is therefore payable on 1 January 2014.
What actually happens in practice of course will rarely be so clear cut as HMRC’s examples envisage, especially when the new legislation includes a subjective test of what a person ‘intended’.
A common scenario would be a situation where directors draw regular amounts in anticipation of clearing any overdrawn balance at the company’s year end by one or more dividends payable within the nine month ‘grace’ period.
Example 4 – A typical situation
Derek draws £6,000 per month from Muggins Ltd in anticipation of dividends. In the past any overdrawn balance on his director’s loan account at the company’s year-end is cleared by a dividend credited after the accounts have been completed and before the end of the nine month period.
At 31 March 2013 there was a debit balance on the loan account of £50,000. On 10 December 2013 a dividend of £50,000 is credited to the loan account, which clears the debt outstanding at 31 March 2013. In the meantime, Derek continues to draw £6,000 per month and by 1 December 2013 the debt stood at £80,000.
It would initially appear that both of the above circumstances would be met because monthly withdrawals of £6,000 continue after the repayment on 10 December 2013. However, since a dividend does not count for the purposes of comparing the amount repaid with the further withdrawals, the amount repaid would be nil which obviously has to be lower than whatever payments by the company are identified with the repayment under either circumstance. There is therefore no restriction of relief under s 458 and no s 455 tax due on 1 January 2014.
Now, if instead of drawing a dividend on 10 December 2013 Derek transfers an asset to the company worth £50,000 that would be a different matter. In that case we have a repayment of £50,000 and a payment within 30 days of £6,000. Since £6,000 is the lower of the two, relief under s 458 would not be given on £6,000 and so notional CT of £1,500 would be payable on 1 January 2014. However we also have a loan of more than £15,000 and at the date of the repayment it is both intended and arranged for monthly payments of £6,000 to continue. Since Circumstance 2 draws in payments made ‘at any time’ where an intention is formed or arrangements made at the time of the repayment, the test seems open-ended. In that case, the lower of the amount repaid and the new payments withdrawn could ultimately be the amount repaid of £50,000. Hence no relief is due under s 458 (or if given may later be withdrawn).
It is worth remembering that where a loan has accumulated over a period of time, repayments are allocated on a first-in first-out basis unless there is any evidence of any other intention. This is a rule of common law established by the case of Devaynes v Noble (1816) 35 ER 781, often cited as Clayton’s case. HMRC accept this precedent and the new rules do not affect the position. Thus in Example 4, when a dividend is credited on 10 December 2013, although the debt stands at that time at £80,000, it is allocated against the £50,000 outstanding at 31 March 2013.
Partnerships and other situations
A detailed expose of how the new rules will affect loans to partnerships and trustees is beyond the scope of this article. These rules will apply to loans or advances made on or after 20 March 2013.
Briefly, where a shareholder of a private company is a member of a partnership (whether a general partnership, a limited liability partnership (‘LLP’) or a limited partnership, if a member of the partnership is also a member of a private company and the company makes a loan to the partnership, in future s 455 will apply to the loan. It had previously been considered that if the company itself is also a member of the partnership, a loan to the partnership could not be considered to be by the company to the other members of the partnership.
Similarly, where a loan is made by a private company to a trust, if either a trustee or beneficiary is also a shareholder in the company, s 455 will apply to loans made on or after 20 March 2013.
Arrangements conferring benefit
A new charge is also being introduced and will apply where, during an accounting period, a private company is party to tax avoidance arrangements which ‘confer benefit’ on a shareholder of the company (or an ‘associate’ of theirs). The following example is based on the HMRC Explanatory Note.
Example 5 – Conferring benefit
Derek and Muggins Ltd are both members of an LLP and under the constitution of the LLP 80% of the partnership profits are allocated to Muggins Ltd. The company pays CT at 20% on its share of the profits but leaves the profits undrawn on capital account. Derek then draws on those funds. Alternatively, Muggins Ltd could have drawn its share of the profits but then reintroduced these as a capital contribution.
In both situations, a benefit is conferred on Derek because he has in effect received funds from Muggins Ltd, there has been no charge under s 455 and Derek does not pay income tax on the funds withdrawn.
Where a benefit is conferred in such circumstances the company is liable to notional CT of 25% for the accounting period in which the benefit was conferred, payable the day after the end of 9 months following the end of the accounting period. If a ‘return payment’ is made to the company in respect of the benefit, relief is given in a similar way to relief under s 458. If therefore a return payment is made within 9 months after the year-end a charge is avoided, otherwise the notional CT is repaid 9 months after the end of the accounting period in which the return payment was made.
Practical Tip :
The main concern for most private companies will be the potential effects of the new rules on directors’ overdrawn loan accounts. Often a game of ‘catch up’ operates where the loan account becomes overdrawn and is then cleared by a dividend after the company’s year end when the accounts are prepared and all the entries have been posted. In the author’s analysis, provided the overdrawn balance is cleared by dividend or remuneration the new rules will not affect the status quo even if further withdrawals are made soon thereafter. If the account is cleared by payment of funds and/or transfer of assets to the company, there must be no intention at that time to make further withdrawals. This may, as noted, be an issue where regular withdrawals are made though these will often be made in anticipation of dividend(s) anyway.
One obvious question is how on earth can the HMRC inspector determine what someone might have intended at the time of the repayment or, for that matter, even become aware of further withdrawals unless the next ‘flavour of the month’ for enquiry becomes overdrawn DLAs? In this respect the new rules may turn out to be a ‘damp squib’ and might only apply in practice where it is blatantly obvious that bed and breakfasting has occurred – and of course assuming inspectors have time to mount such enquiries!