Posted by Simon Misiewicz 16th December 2014
Do you have money locked in a Limited Company?
Would you like to use the money without having to pay tax?
If you have answered yes to either of these questions then this article is for you.
Tax issues need to be diagnosed in order to be understood for a remedy to be implemented.
Many people set up a limited company because of the tax benefits it offers in particular to high income tax rate payers since an individual will pay 40% income tax once they earn over circa £40,000 per year(1). Many people realising this now use a limited company in which to create and hold such income since Corporation tax (paid by a limited company rather than income tax) is much lower at just 20% (2).
The issue with this approach is that the money in the limited company is then locked into the limited company. Why? Simply because it cannot be used for personal use without incurring an even larger tax bill than the 40% income tax the business owner would have paid without the limited company.
Are there ways to release money from a limited company without incurring huge tax bills? We’re delighted to say yes there is.
One option is to take a loan from your limited company to you personally.
Taking this approach may also mean in some circumstances you wont even have to report anything to HMRC or indeed pay tax or National Insurance on some types of loans. This includes loans you provide (4):
- in the normal course of a domestic or family relationship as an individual (not as a company you control, even if you are the sole owner and employee)
- with a combined outstanding value to an employee of less than £10,000 throughout the whole 2014 tax year (£5,000 for the 2013 tax year)
- to an employee for a fixed and invariable period, and at a fixed and invariable rate that was equal to or higher than HMRC’s official interest rate when the loan was taken out
- under identical terms and conditions to the general public as well (this mostly applies to commercial lenders)
- using a director’s loan account as long as it’s not overdrawn throughout the tax year
If you’re a company director and take money out of your company that’s not a salary or a dividend – over and above any money you’ve put in – you’re classed as having received the benefit of a director’s loan.
If your director’s loan account is overdrawn, and you’re a participator (or an associate of a participator) as well as a director, your company must pay tax on any amount you’ve not repaid to the company by 9 months after the end of your Corporation Tax accounting period (5).
By paying back the money in the timescales above your company does not pay tax on the “loan” but you must include details of that loan in your Company Tax Return
Example 1 – lets imagine that your accounting period runs from 1 April 2008 to 31 March 2009. You pay off your director’s loan account on 30 September 2009. You need to include information about this loan on your Company Tax Return but you will not need to pay any tax on the loan. Unfortunately since the 20 March 2013 you do need to pay tax on the loan if you either:
- take a further loan within 30 days of (before or after) the repayment
- have arrangements in place for a further loan to be made at the time of the repayment
Example 2 – you are the owner of a limited company and took a £10,000 loan from your limited company on 28 March 2013. Your limited company has a 31 March year end. You have until 1 January 2014 to repay the loan to prevent incurring any tax on the loan.
If such a loan isn’t repaid within 9 months of the year end date then you must show the amount remaining owed at the end of the financial year in your Company Tax Return. You will also have to pay 25% of the outstanding amount as Corporation Tax known as Section 455 tax. Interest on this Section 455 tax will be added until it or the loan is repaid. You can reclaim the Corporation Tax – but not the interest (7).
There is also no minimum amount against which these rules apply. For example if an individual borrows from their limited company £100 and fails to repay the loan within 9 months and one day of their year end then the company must pay Section 455 tax at 25% of the loan – ie £25.
In addition to the Section 455 tax, a company owner, taking a director’s loan, will also have to contend with benefit in kind rules. These are complicated, because company owners wear more than one hat, ie are limited company shareholders, directors and employees, and are therefore governed by two sets of legislation and tax rules.
Abbott explains: “If a company owners loan exceeds the capped amount any time in the tax year, they pay benefit in kind (BIK). That’s because the company owner has a benefit from their limited company employer which is not charging them interest on the loan.”
The capped amount for the 2013 financial year was £5,000. This has risen to £10,000 from 6 April 2014.
Also the company must pay class 1A National Insurance Contributions (NICs) at 13.8% on the BIK. For example, if a company owner borrows £6,000 over the complete tax year, the BIK is calculated using the ‘beneficial loan rate’, which is an interest rate set by HMRC for each financial year on that £6,000 (6).
Applying the treatment
As described earlier if you are taking a loan from your limited company and you are a participator (see below) then you will need to pay 25% Section 455 tax for any loan balances remaining unpaid over 9 months from your company accounting period end in which the loan was originally taken.
A participator is any person having a share or interest in the capital or income of the company (9).
It is therefore beneficial to make a loan to employees who are not shareholders to avoid this problem. Where a company makes a loan or advance for any purpose to a person who is also a director or employee of that company or of any associated company, the loan or advance will not incur Section 455 tax if all the following conditions are satisfied (9):
- the amount of the loan in question plus the outstanding amounts of loans made to the borrower do not exceed £15,000 (Condition A), and
- the borrower works full time for the company or any of its associated companies (Condition B), and
- the borrower does not have a material interest (see CTM61545) in the company or any of its associated companies (Condition C)
Helpfully where both husband and wife are directors or employees of the company they will each be entitled to a separate loan limit of £15,000.
The rate of interest for the purposes of the loan is (for 2013 as an example) 3.25%. This will be the basis of the commercial “arms length” rate of interest that the company would need to charge its employees (3). This prevents any BIK being chargeable for Income Tax purposes.
Now we have identified the treatment here are a few ways that you can apply it to your tax pains.
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