You’re starting a new business in partnership with a colleague. If your existing business, which operates through a company, provides start-up cash in the form of a loan, are there tax consequences?

Directors’ loan tax charge

You’re probably aware of the tax charge that can apply if you borrow from a close company (one controlled by five or fewer individuals) with which you’re connected, and any of the debt remains outstanding for some while. The tax charge is said to be for directors’ loans, but actually it doesn’t matter if you’re a director or not; where you own or control share capital the charge can apply. Our subscriber’s concern is whether it can apply to a loan from her company to someone with whom she has a business connection.

Trap. The directors’ loan tax charge rules include anti-avoidance measures that can apply where a director shareholder of a company makes a loan to a third party that results in an indirect benefit.

Indirect benefit

Apart from a loan to a family member, there are other common situations where the anti-avoidance rules can trigger the directors’ loan tax charge. First, where a loan is to another company with which the director shareholder is associated. Second, where there is a loan to a partnership to which the director shareholder is connected. The latter might apply to our subscriber’s situation.

A partnership connection

The anti-avoidance measures were made tougher in 2013 to prevent director shareholders from using partnerships as an indirect way of borrowing from their companies while avoiding the directors’ loan tax charge. A loan to a partnership is one in which one or more of the partners is a director shareholder of the lending company.

Example. Molly owns 25% of the ordinary share capital of Acom Ltd. She’s also a partner in Bcom Associates, which is a limited liability partnership. Acom makes a loan to Bcom. The arrangement is within the scope of the directors’ loan tax charge.

A partner connection

Our subscriber’s position was less straightforward than that shown in the example above. Her company, we’ll call it Xcom, will lend to two individuals who will use the money to lend to a partnership of which they and our subscriber are partners. The loan from Xcom is therefore doubly indirect, but does that prevent the director’s loan tax charge from applying?

Trap. What the other individuals do with the money they borrow from Xcom is largely irrelevant. The key factor is our subscriber’s connection with the company lending the money and her association (through the partnership) with the individuals borrowing it. The charge can therefore apply if the loan isn’t repaid in time.

Tip. The directors’ loan tax charge doesn’t apply if the loan is repaid within a short time or, for example, where a company provides goods and services on credit in the course of its trade.

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