By Daniel Hunter
Proposals to change the taxation of loans made by certain companies to their shareholders will increase the tax burden on the UK’s small to medium-sized enterprises (SMEs) by £150 million, says George Lovell, Head of Tax at DTE Business Advisers.
The proposals were announced in a consultation published by the Government last week and seek to radically change the tax applied to the long standing practice of extracting money from a close company by way of a loan to the shareholders.
A close company is one that is controlled by five or fewer individuals, meaning that the vast majority of SMEs in the UK are close companies as they are typically owned by families or small groups of investors.
“It is common practice for the shareholders of a close company to extract funds temporarily by way of a loan. There are good commercial reasons for this, including the lack of certainty that the company has sufficient profits to declare a dividend before the year end accounts have been prepared,” says George Lovell, tax expert, DTE Business Advisers.
“Currently, the company faces a tax charge of 25% of the value of any loans which have not been repaid by the shareholder within nine months after the end of the company’s accounting year. The tax is repaid to the company once the shareholder has repaid the loan, so this is largely a temporary tax designed to replicate the tax cost as if the shareholder had taken a dividend in the first place instead of a loan.
“The making of a loan to the shareholder doesn’t create an income tax liability for the shareholder; however they will suffer an income tax charge if the loan is interest free.”
The consultation sets out the Government’s plans to raise more tax from this area. One alternative is to raise the temporary tax charge on the company from 25% to 40%. The second is to levy a permanent annual charge at a lower rate — potentially 5% - on either the loan balance outstanding at the year-end or the average balance over the year.
“The Government’s objective seems to be to encourage, or even force, the owners of small and medium sized businesses to extract more money from their businesses in either salary or dividends so that they have higher tax bills,” explains George Lovell.
“The permanent annual charge seems particularly harsh as it would lead to multiple tax charges on the same amount of money where a loan is outstanding for several years.”
Government figures show that in 2011 the value of loans owed to close companies by their shareholders stood at £1 billion.
“If the temporary tax charge is increased from 25% to 40%, in the medium term this could give the Treasury a cash boost of £150 million,” Lovell added.
The consultation period closes on 2 October with a view to introducing new legislation in April 2014.
Join us on