A number of company directors receive loans from their companies, either to reinvest in the business or for personal use. Until recently the laws surrounding such a transaction have been stringent. However, from the 6th of April 2014 things have changed, albeit for the better, making it easier to take loans from your own company. This article will briefly cover the rules pre-April 2014 and then the new changes.
The Rules Pre-April 2014
Previously when an employee of a company received an interest free or a very “cheap” loan it could be treated as a taxable benefit. The interest rate for loans to employees is determined by the HMRC and was at 4.0% before the 6th of April. For a loan to be classed as taxable, or a benefit in kind, it has to exceed the threshold value which at set at £10,000.
A calculation is required to determine whether a loan breaches this threshold, by taking the loan amount and applying the gazetted interest rate, then taking away any interest already paid by the loaned.
Taking as an example, if you borrowed £10,000 from your company, at the official rate of 4.0% you would be liable for a £400 taxable benefit. However, since it is below the £5,000 threshold you would receive it as a benefit in kind. Once it goes over £5,000 you would have to pay tax on it.
With effect from the 6th of April 2014 the threshold value has been lifted to double the previous value and it is now £10,000. This has the implication that you can now borrow up to £10,000 from your company without paying any tax on it (it is regarded as a non taxable benefit). Another change has been to the rate of interest you will pay if you exceed the £10,000 threshold, which has been reduced modestly from 4.0% to 3.25%.
This loan facility has often been open to abuse and recent changes have been made to tighten the process up. The biggest risk has been company directors borrowing money from their companies and then using it as a way to avoid tax by holding the loan indefinitely.
The new rules now mean that a company can no longer loan money to an employee indefinitely without meeting the tax burden. When a loan is still outstanding 9 months after a company’s yearend then 25% in tax will be levied on the outstanding amount. A refund of the tax charges will be made when the loan amount is repaid in full or it is written off. This has been necessary to avoid a common practise which involved paying back the loan just before the nine months were up and then borrowing the same amount shortly thereafter.
To prevent the practice mentioned above a new rule has been passed, applying to all companies with yearends beyond March 20 2014. If a company repays a loan just shy of the 90 day period and then another loan extended within 30 days of the repayment, HMRC will consider the repayment as a non-repayment and the 25% tax rate will be applied.
Another common practice has been for a company to arrange a “bridging” loan in order to repay the original loan before the 90 days are up. The company would then make a repayment after the 30 day period in order to circumvent the rules. HMRC now watches out for this practise and if a company is found to have done this then the repayment is ignored and tax charged on the outstanding loan amount.
As you can see although the changes have made the system more generous, safeguards have also been put in place to ensure that it is not abused. As a director you can now have the option of a bigger loan from your company tax free, but you also have to take responsibility for paying it back and keeping within the rules.