Neither a borrower nor a lender be”….. Loans to and from Family Companies

Neither a borrower nor a lender be”….. Loans to and from Family Companies
Polonius’ advice to his son in Shakespeare’s ‘Hamlet’ might apply to family companies and their shareholders – I have seen too many people get themselves into trouble with HMRC as a result of being careless about loans to and from their companies. This article looks at the tax treatment of such loans, and points out the pitfalls and the planning opportunities.


Loans to the Company


In many cases, family companies, particularly in their early years, need finance provided by their shareholders and the shareholders need to borrow the money in order to lend it to the company.


Provided the company is either a trading company or a property investment company, then interest on a loan which is used to lend money to that company is an allowable deduction for the lender. If the lender “recovers capital” from the company (broadly, if the company repays him all or part of the loan) then that repayment is deemed to have been used to repay all or part of the individual’s loan (even if it is not in fact used for this purpose), and so that proportion of the interest being paid on the loan is no longer an allowable deduction.


If the company pays the shareholder interest on the loan, then the company is required to deduct income tax from that interest and to account for it on a form CT61 each quarter.


Finally, if the loan goes bad, there may be some tax relief for the lender. The conditions are:


The loan was made to a trader (note this could apply to a loan to another individual as well as to a company)
The trader used the loan for the purposes of the trade
The loan has become irrecoverable but not as a result of anything done by the lender.

In these circumstances, the amount of the loan that has become irrecoverable can be treated by the lender as a capital loss to set against any capital gains of the year, or of later years.


Loans from the Company


If a “close” company (broadly, a company controlled by 5 or fewer shareholders – almost all family companies are “close” companies) lends money to a shareholder (or to his family, or to a partnership of which he is a member) then there are various tax consequences:


Tax on the Company


The company has to pay a form of tax (known as “section 419 tax”) on the amount of the loan – charged at the rate of 25% of the loan. This tax is repayable when the loan is repaid to the company and the timing of the repayment is important:


If the loan is repaid within 9 months of the end of the accounting period in which it was made, then no section 419 tax is due.
If the loan has not been repaid by then, the section 419 tax is payable and will only be repaid 9 months after the end of the accounting period in which the loan is repaid.

For example:


Company X lends £5,000 to one of its shareholders during its accounting period ending on 31 December 2006. The loan is repaid on 20 September 2007, which is less than 9 months after the end of the 31 December accounting period, so no section 419 tax is due.

Company Y makes a similar loan during the same accounting period. The loan is not repaid until 5 October 2007, which is more than 9 months after the end of the accounting period. Section 419 tax is payable (on 1 October 2007) and will not be repaid until 1 October 2008 (nine months after the end of the accounting period in which the loan was repaid).

These rules also apply where instead of being repaid the loan is “released” by the company – that is where the company formally releases the shareholder from the obligation to repay the loan.


Tax on the Shareholder


In these cases, the shareholder will almost certainly be a director and so a loan to him will be treated as a benefit in kind from his employment. Unless he pays the company interest at the “official rate” published by HMRC from time to time (currently 6.25 % per year), then he will be taxed on a benefit calculated at that rate:


Mr B borrows £10,000 from a company of which he is a director on 6 April 2006. He has not repaid the loan by 5 April 2007. The “official rate” for the 2006/07 tax year was 5%, so unless Mr B has paid interest to the company of £500 (£10,000 at 5%) he will be taxed on a benefit in kind of £500, which will cost him £200 in tax if he is a higher rate taxpayer, and the company will have to pay NIC of £64.


There are two exceptions to this rule – the following loans do not produce a charge to income tax:


A loan where all the interest paid would attract tax relief – for example, a loan to buy a share in a partnership or in certain types of companies
A loan where the total of all loans from the company to the director is never more than £5,000 during the tax year

Loans Written Off


I have already mentioned the tax treatment for the company. Assuming the loan is from a close company to a shareholder, the writing off is treated as if the company had paid him a dividend, so if he is a higher rate taxpayer and the loan written off is £10,000, he will be liable to income tax of £2,500 (25% of the amount written off).


There may be a planning opportunity here in some circumstances – but that is a subject for another article.