New HMRC enforcement campaign targets directors’ loans

Subject to certain exceptions, directors’ loans can give rise to taxable benefits in kind if they are interest free, or if interest is paid at less than the official rate (currently 3.75 percent per annum). Currently, annual employment related loan benefits should be reported on Form P11D, and are subject to income tax through self-assessment and Class 1A (employer only) NIC.

The requirement that interest must actually be paid to reduce or remove a taxable benefit can often be overlooked, and HMRC do not accept that interest added to a loan account results in payment being made. Therefore, whilst individuals can reclaim income tax paid on beneficial loans once any interest due has been paid, this is subject to time limits which mean that ‘rolling up’ interest can result in irrecoverable income tax, and Class 1A NIC being paid.

The basic position is that any part of a director’s loan that’s released is taxable as earnings. Like the annual beneficial loan charge, this is currently reportable on Form P11D with the income tax due paid through self-assessment. However, unlike the annual beneficial loan charge, these earnings are subject to Class 1 (employer and employee) NIC through payroll, rather than to Class 1A (employer only) NIC.

However, if the company making the loan is ‘close’, and the relevant director is, or is an associate of, a ‘participator’, the released loan can be taxable at dividend income tax rates of up to 39.35 percent, rather than at the rates applicable to earnings of up to 45 percent (or up to 48 percent for Scottish taxpayers). Broadly, and subject to certain exceptions, a company will be ‘close’ if it is controlled by five or fewer ‘participators’, which include individuals with a share or interest in the company’s capital or income (e.g. shareholders or those who have a right to acquire shares).

The NIC position when a close company participator director’s loan is released can be more nuanced. A First-tier Tribunal decision suggests that the NIC position might be determined by whether the loan was released because the borrower was a director – in which case NIC will be due – or because they were a shareholder (or other participator) – in which case it might not.

A loan from a close company to a director who is, or is associated with, a participator can give rise to a tax charge on the company (often referred to as a ‘section 455 charge’).

A section 455 charge is levied at 33.75 percent of the loan that remains outstanding nine months after the end of the accounting period in which it’s made, and the tax paid can be reclaimed nine months after the end of the accounting period in which the loan is released. However, if an historical failure to pay a section 455 charge is identified (e.g. when confirming whether the release of a loan was correctly disclosed in the director’s personal tax return), it might still be necessary to pay that tax, plus interest on late payment, to HMRC.

A close company is unable to claim a corporation tax deduction in respect of any participator loans that are released or written off.

If a company that is not close releases a director’s loan, the corporation tax deductibility would need to be considered in accordance with basic tax principles. Key factors in determining deductibility might include the ability to demonstrate that the release is an expense wholly and exclusively incurred for the purposes of the trade or, where the director’s loan arose from lending transactions, that the release is amongst the commercial or business purposes of the company.

As directors’ loans are a current focus for HMRC, regardless of whether an individual director receives a ‘nudge’ letter, both companies and their directors should ensure that they fully understand the personal, employment and company tax treatment of any director loans. They should also be satisfied that, if required to do so, they could evidence that they take reasonable care to discharge their compliance obligations correctly.

Practical considerations include how the company could demonstrate to HMRC that it has robust processes in places to ensure that:

• All loans to directors, and other employment related loans, are identified (this includes any form of credit, so potentially any amounts owed to the company by directors or other employees could be ‘loans’ for these purposes);
• Any loans to directors or other employees, and other loans or advances of money, that could give rise to section 455 charges are identified (here ‘loans’ includes debts incurred, or receivables assigned, to the company, and monitoring whether a company is ‘close’ and the identities of participators and their associates can be complex);
• The company is aware when loans to directors or other employees are released (this won’t necessarily be straightforward, for example novation of a loan could constitute a release);
• The income tax and NIC treatments of loans made to directors or other employees are appropriately considered (e.g. annual benefit in kind charges where interest is capitalised or ‘rolled up’ unpaid, and/or the potential interaction of the employment tax and loans to participator rules if a loan is released); and
• The company pays any section 455 charges that arise by the applicable deadline.

As an omission in one area might prompt a wider HMRC review, directors who receive a ‘nudge’ letter should consider whether all their personal tax affairs are up to date. Additionally, and taking account of their position as directors, before responding to HMRC they should consider making the company aware of HMRC’s letter, and whether it would be appropriate for the director and the company to coordinate their responses.

Please contact the authors, or your usual KPMG in the UK contact, to talk through how HMRC’s new enforcement activity might affect you or your business. Our multidisciplinary team of personal, employment and company tax experts can support you with all aspects of tax governance, compliance and remediation.

For further information please contact:

• Colin Purdue
• Rob Shannon