Loans to Participators - wider than you might expect

In this Tax Bite, we look very briefly the often-overlooked loans to participators rules. These rules are something to be aware of whenever you are dealing with a close company, which in broad terms is a company that is controlled by five or fewer “participators” (i.e. shareholders and their associates).

If a close company makes a loan to a participator, and the loan remains outstanding 9 months after the end of the accounting period, the company must lodge an amount equal to 32.5% of the outstanding loan with HMRC as if it were an amount of corporation tax. So in essence the rules stop close companies loaning sums to shareholders for long periods of time without triggering a tax payment.

This “tax” is repaid 9 months after the end of the accounting period in which the loan is repaid (or indeed written off), so in effect it is a deposit in respect of the income tax that HMRC ultimately expects to be payable, which is why the rate is set at the higher rate for dividend income tax.

That is the basic rule in a nutshell, however there is also another rule applying the same tax treatment where there is an “indirect” loan to a participator. This rule is wide and applies where a close company makes a loan that is not caught by the basic rule, someone other than the close company makes a payment to, transfers property to or releases or satisfies a liability of a participator, and the two events are part of arrangements made by the same person.

One common practical situation where this charge can arise is on an acquisition, where the cash consideration to an exiting shareholder is funded from cash of the target company. A loan to newco of the funds to pay the consideration would usually at least initially be made as even if the close company has sufficient reserves to pay a dividend of the amount required it would not do so before newco is registered as the owner of the shares. As long as the loan is discharged by declaration of a dividend before the date which is 9 months after the year end there is no issue. If that is not done (e.g. if there are insufficient reserves) then the loan to participator charge will arise. This might seem unfair as the individual participator is receiving the proceeds due to him or her for his shares rather than a loan, but the rule is widely written.

We have also come across situations in practice where the parties have taken steps to address these so-called ‘upstream loans’ (typically by declaring dividends that allow the balances to be set off against each other), but if the final step is not taken to recognise in the books that the owed dividend is used in settling the loan, the indirect loan to participator tax charge would still arise.

It must always be remembered that the amount paid to HMRC under these rules will always ultimately be refunded so it is not tax as such. But if the amount hasn’t been paid because the point has been missed, HMRC are still liable to insist that the outstanding payment be made to them even if it is clear it will be repayable only a matter of months later, plus of course interest and potentially penalties could apply on the underpaid amount.

In summary on all transactions where funds in the target are being used to help fund the transaction this point should be considered. If there are reserves to match the loan it can easily be dealt with. If there are not, then the parties should consider on the forecasts whether sufficient reserves will be generated before 9 months after the year end and if not the 459 charge should be built in to the cash flows.

Posted on 07/02/2022 in Tax News


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