PQ tax
Close companies
simplified! In the latest article in his ‘Keep It Simple’ series, Neil Da Costa tackles a popular topic that features regularly in tax exams: close companies
depend on whether the individual is employed by the company. Employees will be taxed on a loan benefit while shareholders that are not employees will be taxed on dividends. Loans to participators (notional tax implications) If the loan is outstanding nine months and one day after the accounting period ends the close company must pay notional tax based on 32.5% of the loan. HMRC will refund the notional tax to the close company if the loan is repaid or written off. The write off of the loan will result in the shareholder being taxed on a dividend. There is no notional tax payable if three conditions are satisfied. The loan should not exceed £15,000, the participator is a full-time employee of the close company and does not own more than 5% OSC. Simple example: Close Ltd Close Ltd has three shareholders, each of whom own 33.3% share capital. The shareholders are Ibrahim, Jana and Sophie. They can be assumed to be additional rate taxpayers. Ibrahim and Jana are full time directors of Close Ltd while Sophie is not employed by Close Ltd. Close Ltd gives a loan of £100,000 to each of the three shareholders and the entire amount is still outstanding when the corporation tax is due. What would happen if Close Ltd writes off the loan made to Jana?
Underlying concept Close companies are usually family-owned companies. As a result, the family could take disguised remuneration from the close company in the form of loans which are not paid back. HMRC have introduced anti-avoidance rules to prevent this. The close company must pay notional tax based on 32.5% of the loan with the corporation tax liability under s455 CTA 2010. Definition of a close company Close companies are controlled (51% ordinary share capital or voting rights) by five or less shareholders called participators. A participator and associates are treated a single person for this test. Unlike other definitions in tax, an associate here not only includes a spouse but all lineal ancestors and descendants and siblings. Simple example: Happy Ltd Happy Ltd has six large shareholders, each of whom own 9% of the share capital. The shareholders are Dexter, Oliver, Toby, Kai, Freya and Lily. The other shareholders all own less than 1% and are not related. Would Happy Ltd be a close company if the shareholders were not related? What would happen if Dexter and Freya are brother and sister? 30
Solution to Happy Ltd If none of the shareholders are related, then the maximum shareholding that five shareholders own is 5 x 9 = 45%, which is less than 51%, so Happy Ltd is not a close company. However, if Dexter and Freya are siblings then Freya becomes an associate of Dexter, and they are treated as a single person. This means that five shareholders own 54%, which is 51% or more. Happy Ltd is controlled by five or less shareholders or participators and would be treated as a close company. Loans to participators (income tax implications) When a close company makes a loan to a participator, the income tax implications will
Solution to Close Ltd Ibrahim (employed, £100,000 loan) Income tax implications – Ibrahim will have a P-11D benefit of £100,000 x 2.25% (HMRC official rate of interest) = £2,250. This will attract an income tax liability of £2,250 x 45% = £1,013. National Insurance Implications – Ibrahim does not have to pay employee Class 1 NIC on the benefit but Close Ltd would be required to pay employer’s Class 1A NIC on the benefit at 13.8%. £2,250 x 13.8% = £311. Notional tax implications – Close Ltd will pay notional tax of £100,000 x 32.5% = £32,500 with the corporation tax. Jana (employed, £100,000 loan) The income tax, NIC and notional tax implications would be identical to Ibrahim. However, when Close Ltd writes off the loan, the notional tax of £32,500 will be refunded to Close Ltd. No tax deduction is available to the company. Jana will have to pay income tax on a dividend of £100,000. The first £2,000 will be taxed at 0% while the balance of £98,000 at £38.1%, resulting in income tax of £37,338. Sophie (shareholder, £100,000 loan) Income tax implications – Sophie will be taxed on a dividend of £2,250. The first £2,000 will be taxed at 0% while the balance of £250 at £38.1%, resulting in income tax of £95. National Insurance implications – no NIC on dividends. Notional tax implications – Close Ltd will pay notional tax of £100,000 x 32.5% = £32,500 with the corporation tax. • Neil Da Costa is a Senior Tax Lecturer with Kaplan in London. He is the author of Advanced Tax Condensed, which summarises the entire syllabus using memory joggers PQ Magazine August 2021
