The rate of ‘temporary’ tax charged on loans to participators in close companies has been increased from 25% to 32.5%, with the increased rate applying to loans made on or after 6 April 2016.
Very broadly, your company will be classed as close if it is controlled by five or fewer participators – usually shareholders – or by any number of participators if they are also directors. If it were not for the close company loan rules, it would be very easy to take tax-free loans rather than taxable remuneration or dividends.
The tax treatment of a close company loan can be quite complicated because the employment income beneficial loan rules can also come into play. The 32.5% charge applies only to loans to participators, whether or not they are directors. However, loans to directors can also be taxed as beneficial loans regardless of whether they are participators.
You may think that this does not affect you, but it is surprisingly easy for a director’s current account to become overdrawn – which would be treated as a loan. Remember that any personal expenses which have been paid from the company’s bank account may be charged to your loan account. A typical strategy would be to cover the debt by declaring a dividend, but this will not be possible if company profits are insufficient – such as when a loss has been made. A better approach may be to vote salary and/or dividends at the start of the year so that you have funds available to draw upon.
Although it’s a good idea to simply avoid overdrawing your loan account, there might be a situation when you really need a short-term company loan. With careful timing, you can make use of company funds for up to 21 months without having to pay the 32.5% charge. And if a charge is paid, timing is also important when it comes to repayment.
Doing this just before the company’s year-end, rather than just after, results in a one year earlier tax repayment. If your spouse or partner is also a director and their loan account is in credit, then that balance could be used to offset your overdrawn account. However, for this work, the two accounts must effectively be operated jointly.