The general rule
As a general rule, the ‘Loans to Participators’ provisions of CTA 2010, Pt 10, Ch. 3 imposes a 25% tax charge on close companies in respect of overdrawn directors’ loan account to the extent that the loan is not repaid within 9 months after the end of the company’s accounting period in which the loan is made (CTA 2010, S455(3)).
S455(3) charge can be avoided by repaying the loan before the 9 months’ period as above and a relief from the tax charge is available if the loan is repaid or written off after the 9 months’ period. (S 458)
Bed and breakfasting rule trap to avoid
Bed and breakfasting involves the repayment of the overdrawn loan account balance within the accounting period or within the 9 months after the accounting period to eliminate the 25% tax charge, and then withdraw a similar or greater amount from the close company shortly thereafter.
The anti-avoidance provisions of CTA 2010, S 464C have been introduced to denied or withdraw the tax relief from such practice and may apply in the following circumstances:
- 30 day’ rule – i.e. where, within any 30-day period, loan account repayment(s) of £5000 or more are made to the close company, and a further amount of £5000 or more is withdrawn by that person in an accounting period subsequent to the one in which the loan was made; or
- ‘arrangements rule’ – i.e. where a loan (e.g. overdrawn loan account) is at least £15000, and at the time of repayment there are arrangements for replacement withdrawal(s) by the person pf at least £5000, and the withdrawal(s) is subsequently made (at any time after the repayment). ‘Arrangements’ is considered to have a wide meaning in HMRC’s view (see its Company Taxation manual at CTM61635)
If you fall within the remits of the above rules, the repayment is treating as repaying the new loan (s) rather than the earlier or old loan(s), consequently the relief from the 25% tax charge is wholly or partly denied or withdrawn in respect of the old loan(s), with relief only available the extent that the extent that the repayment exceeds the new (loan).
The above anti-avoidance rules do not apply if the directors’ loan account gives rise to an income tax charge on the directors’ shareholder (see below).
HMRC accepts that repayments can be made via ‘book entries’ in the company’s accounting records, at the date when the book entries are made (see CTM61600).
The most common ways for a director shareholder to repay an overdrawn directors’ loan account balance in a ‘taxable’ form is by crediting the loan account with their salary or bonus from the company.
In a similar way, a dividend from the company may be credited to the loan account and repayments by salary, bonus or dividend are generally considered to be exceptions from the ‘bed and breakfasting’ anti-avoidance rules. However, care is needed as to the date or ‘payment’ of the salary, bonus or dividend for these purposes.
It is also important to note that if the salary, bonus or dividend is paid out in cash to the director shareholder, and is later reintroduced into the company and credited to the director’s loan account, this loan account repayment does not fall within the above exception to the anti-avoidance rules in HMRC’s view (see CTM61642).