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In the 2016 budget, the chancellor increased the rate of tax that companies must play when lending money to their directors. Avoiding the tax can be done through clearing the debt with a bonus, but how is it done?
Company Loans Tax
When a director shareholders borrows from their company, it triggers two tax charges. One of these applies to the director, whilst the other applies to the company. The first comes into account if the borrowing exceeds £10,000 in a tax year. Shortly before the end of the financial year end, a resolution should be passed promising a bonus payment within the next 9 months. This bonus payment can be used to clear debt, and by committing to the payment before the end of the tax year, tax charges are prevented from airising.
The second method, though temporary can be highly significant, and even more so if the tax rate increases from 25% to 32.5% for borrowing made after 5 April 2016.
If money is still owed at the end of the financial year, the company must pay a tax know as a S.455 charge, equal to 32.5%of the amount you’re still owing nine months later. The tax will be refunded nine months after the end of the financial year and what is owed would be repaid, meaning there is a large possibility that the company could be out of pocket for a considerable length of time.
To prevent the S.455 from been triggered, you could repay what you owe the company with 9 months following the end of the financial year.
If repaying the debt within the 9 months since the end of the financial year is not possible, the S.455 tax can still be avoided by the company declaring a bonus for the debt holder and using it to clear said debt. First though, the company must deduct PAYE tax and NI from the bonus. Further, if the decision to pay a bonus is made after the end of the financial year, the S.455 charge will stand.
The trouble is that the amount of bonus to repay isn’t usually known until after the end of the financial year. A fee could be estimated, but without the exact figure its cant be guaranteed to cover the amount of the debt. Additionally, often adjustments to the debt are needed when the company’s accounts are prepared making it more difficult to estimate.
To overcome this, a company can pass a resolution that states the company will pay a bonus that, after tax and NI, will be enough to cover the costs of the debt. This creates a guarantee that the company will pay the bonus prior to the year end.