Tax Efficient Loans From Your Company

Sarah Bradford explores when it can be beneficial to borrow money from your company and the tax implications of doing so.

With Christmas approaching, many people’s finances are stretched and the option of some extra money to tide you over the festive period may be appealing. However, arranging a commercial loan or ‘maxing out’ your credit card can be very expensive.

If you have a personal or family company, borrowing from the company can be an attractive option, particularly where a loan is only needed for a short period. However, it is possible to enjoy a loan from the company for up to 21 months tax-free, as long as the loan balance is less than £10,000. Where the loan balance tops £10,000 at any point, there is a benefit-in-kind tax charge – but this may be a small price to pay.

Understandably, the taxman would not be happy with directors enjoying tax-free loans indefinitely, and tax (‘section 455 tax’) is charged on the company where a loan that is outstanding at the end of the accounting period has not been repaid by the normal due date – nine months and one day after the end of the accounting period. There are reporting obligations to be aware of too.

A 21-month tax-free loan of up to £10,000

To stay tax-free the loan must not trigger either a section 455 charge or a tax charge under the benefit-in-kind rules.

The section 455 charge (ie under CTA 2010, s 455) applies where the loan (or overdrawn director’s account balance) has not been cleared within nine months and one day of the end of the accounting period in which the loan was taken out. This allows a maximum window of 21 months in which to enjoy a loan without incurring a section 455 tax charge.

To benefit from the loan for the maximum possible period, the loan needs to be taken out at the start of the accounting period. This will allow the director to enjoy the loan throughout the 12-month accounting period and for a further nine months after the end of the accounting period before it needs to be cleared (or section 455 tax paid) – a total of 21 months. Even if the loan is taken out towards the end of the accounting period, the director can benefit from it tax and interest-free for at least nine months.

From a benefit-in-kind perspective, the tax charge on cheap and interest-free loans does not apply as long as the loan balance does not exceed £10,000 at any point in the tax year. All loans that the director has with the company must be aggregated in working out if the £10,000 limit has been breached.

It is important to keep an eye on the loan balance, because if it exceeds £10,000 at any point – even if only for one day – the small loans exemption is lost and the benefits-in-kind charge will apply for the full period in the tax year for which the loan is outstanding.

Example 1 - Tax-free company loan

Terry is the director of his family company, which is ‘close’ (ie broadly closely-controlled). The company prepares accounts to 30 November each year. He wishes to treat his family to a holiday over the Christmas period, and borrows £8,000 from the company on 5 December 2017.

As long as he repays the loan in full by 1 September 2019 and his borrowings from the company remain below £10,000, he can enjoy the loan interest-free and tax-free for nearly 21 months.

By comparison, had he borrowed the money at an interest rate of 6% for the same period, he would have paid interest of £840 for a 21-month loan.

Loan of more than £10,000

If the company has the funds available, it can still be much cheaper to borrow money from your family or personal company and pay the benefit-in-kind tax charge than to take out a commercial loan.

Where the loan exceeds £10,000 at any point in the tax year, the benefit of the cheap or interest-free loan is taxed. The amount that is charged to tax is found by comparing the interest that would be payable at the official rate with the interest actually paid, if any. For 2015/16 and 2016/17, the official rate of interest is 3%, falling to 2.5% from 6 April 2017.

Example 2 – Company loan of £40,000

Lorraine borrows £40,000 from her family company. The loan is interest-free. The company prepares accounts to 31 March each year. Lorraine takes out the loan on 6 April 2016, and it is outstanding throughout the 2016/17 tax year. Lorraine pays no interest on the loan.

For 2016/17, she must pay a benefit-in-kind charge. The cash equivalent of the benefit is £1,200 (being the loan balance of £40,000 at the official rate of interest of 3%).

Lorraine is a higher rate taxpayer and will pay tax of £480 on the benefit. The company will also suffer a Class 1A charge of £165.60 (£1,200 @ 13.85%).

By contrast, if Lorraine had taken out a £40,000 loan for a year from a commercial lender at a rate of 6%, she would have paid £2,400 in interest. Borrowing from her company and paying the tax on the benefit of the loan saves her £1,920.

As long as Lorraine repays the loan by 1 January 2018, there will be no section 455 tax for the company to pay. She will, however, pay a further benefit-in-kind tax charge to the extent the loan remains outstanding in the 2017/18 tax year.

Where the company declares a dividend and credits it to the account, Lorraine will be taxed at the appropriate dividend rate. Where the loan is cleared by means of a salary or bonus payment, tax under PAYE must be deducted, as must Class 1 National Insurance contributions. The company must comply with the reporting requirements imposed by real-time information.

While clearing the loan will prevent a section 455 liability from arising, this will not always be the best route, as the tax payable on the dividend, salary, or bonus payment may exceed the section 455 tax that would be payable if the loan remained outstanding.

Loan still outstanding at the trigger date

Where the loan remains outstanding nine months and one day after the end of the accounting period in which it was made, the company will need to pay section 455 tax with its corporation tax for the period. The rate of section 455 tax is linked to the higher dividend rate, and is set at 32.5% for loans taken out on or after 6 April 2016.

Section 455 tax is a temporary tax in that it is repaid if the loan is cleared – the repayment can be claimed nine months and one day after the end of the accounting period in which the loan was repaid.

If the loan is outstanding at the end of the accounting period but cleared before the trigger date, it must still be reported to HMRC as part of the company tax return.

Anti-avoidance

Anti-avoidance rules exist which prevent exploitation of the rules by repaying the loan shortly before the trigger date and re-borrowing the money shortly after (`bed and breakfasting’) in a bid to extend the tax-free period.

Practical Tip:

Where a personal or family company has funds available, borrowing from the company can be a cheap source of finance – it is possible to enjoy a loan of up to £10,000 for up to 21 months free of tax without falling foul of the rules.