Q&A: directors’ loans and tax liability

In our regular Q&A series from Croner Taxwise, Alexander McCarthy explores how to minimise interest on a benefit loan charge

Q: Many of my small company clients often have overdrawn director loan accounts. When considering minimising the beneficial loan charge, what interest can be taken into account to reduce or cancel the benefit charge?

A: The employment-related loan legislation is designed to tax the benefit of a loan to an employee or officer where the loan value is over £10,000 at any time in the tax year and either no interest is paid or interest below the official rate (currently 2.5%) is paid by the borrower.

Although there is often an area of overlap between the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) beneficial loan charge and the loan to participators legislation in s455,Corporation Tax Act 2010  (CTA 2010) they are separate and distinct issues.

Section 175(3) (b) (ITEPA 2003) states that the benefit in kind is reduced by the amount of the interest paid. In HMRC’s view (see HMRC Employment Manual  EIM26250), for the interest to have been paid, the following conditions must be met:

  • the interest must be paid;
  • the interest must be paid for the year of assessment, but not necessarily in the year of assessment;
  • HMRC require an obligation to pay the interest during the tax year (see EIM26257); and
  • HMRC do not accept that interest that is capitalised has actually been paid (see EIM26251).

HMRC’s view in EIM26250 is that interest cannot arise except under an obligation. Thus, a voluntary payment cannot be interest. Considering this, we would advise that a formal loan agreement be put in place in order to prove this obligation exists.

HMRC’s view in EIM26251 which refers to supporting case law is that capitalising interest does not constitute a payment of interest and so the s175 charge still arises.

Finally, note that interest cannot be backdated (see Savings and Investment Manual SAIM2040). Therefore, the obligation to pay interest must be in place throughout the period concerned.

About the author

Alexander McCarthy is a trainee tax adviser at Croner Taxwise, tel: 0844 892 2470  

This article first appeared on Croner Taxwise

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