A close company in the UK is a resident company controlled by five or less shareholders (also called participators) or any number of directors who are also shareholders. The rules governing close companies are in place to prevent shareholders and directors from using company funds as their own personal resources.
There are two primary arrangements commonly seen in close companies: benefits provided to participators and loans to participators. We will explore each in turn.
Benefits to Participators
When a shareholder is also an employee or director of the close company, any benefits they receive from the company are taxed under the earnings rules. This means the company must pay Class 1A National Insurance Contributions (NIC) on the benefit provided, and the P11D value is added to the employee’s tax return or processed via payroll.
If the shareholder is not an employee of the company, the benefits they receive are not considered earnings and are therefore treated as dividends. However, the following benefits are not subject to dividend rules:
Benefits to employees, which are taxed under the earnings rules.
Living accommodation, if it falls within the exceptions under the earnings rules.
Pensions, annuity lump sums, or payments to the employee’s spouse or dependents upon the employee's death or retirement.
Beneficial Loans
When a company makes a loan to a participator with no interest or with interest charged below the official rate (ORI), a taxable benefit arises. If the loan is made to a shareholder who is also an employee of the company, and the loan exceeds £10,000, the benefit must be reported on the P11D and is taxed under the earnings rules.
Beyond the personal tax implications for the participator, the company also faces corporate tax consequences. The company must pay a ‘Section 455’ tax charge on the loan amount, currently set at 33.75%, in line with the higher dividend rate.
For the ‘Section 455’ tax calculation, the loan amount is the lower of:
The amount outstanding on the last day of the accounting period, or
The amount outstanding on the normal due date, which is nine months and one day after the end of the accounting period.
This additional charge is added to the company’s corporation tax liability for the period unless the loan is repaid before the tax is due.
‘Section 455’ tax can be reclaimed by the company if the loan is repaid or written off. To claim the refund, the company can apply to HMRC from nine months and one day of the end of the accounting period in which the repayment or write-off occurred. Claims must be made within four years from the end of the accounting period in which the loan is repaid.
If the loan is written off, the company can reclaim the tax, but the write-off itself is not deductible. The loan write-off will be treated as a dividend to the participator, which may have additional personal tax implications.
If the participator is also an employee of the company and the loan is written off, this will also trigger Class 1 NICs for both the employee and the company.
‘Bed and Breakfasting’
In the past, some participators exploited the ‘Section 455’ rules by repaying the loan just before the due date for the ‘Section 455’ tax payment and then borrowing the same amount again shortly after. This allowed the participator to only lose the use of the funds for a few days, thus avoiding the tax charge. This practice became known as ‘Bed and breakfasting’ the loan.
To prevent this, the rules now restrict the repayment of ‘Section 455’ tax if, within a 30-day period, a participator repays a loan of £5,000 or more to the company and subsequently borrows the same or more amount from the company in the following accounting period. In this scenario, the repayment is treated as a repayment of a subsequent loan, rather than the original loan.
Speak to an Expert
If you have withdrawn money from the business via loan and are unsure about the tax implications for both the company and yourself, or if you would like to explore the most tax-efficient method for extracting funds from your business, please contact us. We are happy to assist you.
Authored by: London Tax Team
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