Borrowing cash from your company can result in extra corporation tax. Special rules prevent dodging the tax by temporarily repaying the debt. How can you legitimately escape the tax charge?
Company money
As a director shareholder if you’ve borrowed money from your company which you still owe when its financial year ends, it will have to pay a tax charge equal to 32.5% of whatever remains owing nine months later. The good news is that HMRC will refund the tax after the end of the financial year in which the debt is repaid. Better still, the tax charge can be avoided altogether if the debt is cleared within the nine-month period.
Repayment options
You could repay the loan from your own resources, but this probably isn’t an option given that you needed to borrow the money in the first place. Alternatively, your company could declare a dividend and instead of paying it to you, it’s used to clear what you owe. However, there can be obstacles to this.
Trap. Your company can only pay a dividend up to the amount of its profits. Plus, the profits must be sufficient to pay a dividend to all other shareholders with the same type of shares as you.
Alternative repayment options
While a dividend is the most tax-efficient method of clearing what you owe, it can be cleared by your company paying you extra salary. The trouble is this triggers immediate PAYE tax and NI liabilities which must be deducted from the salary and only the net amount is available to clear the loan. This makes it a costly option.
Example. To clear a debt of £25,000, assuming you’re a basic rate taxpayer, would need a salary payment of £34,722. Your company would also have to pay employers’ NI of £4,791 (£34,722 x 13.8%). This means it would have to find £14,513 in PAYE tax and NI just to avoid the 33.75% tax charge of £8,437 (£25,000), and within the same time scale. Corporation tax (CT) relief for the salary and NI of £7,507 (assuming the small profits rate of 19% applies) will reduce this cost but it will be another year before this is received which means the £14,513 still has to be found. Accepting the 33.75% tax is the better option until the debt can be cleared with a dividend.
By comparison to the cost of salary, £32,005 after CT relief, a dividend that was sufficient to clear your debt would cost your company £27,397 without any PAYE tax to NI find.
Tip. Writing off the debt can be as tax and NI efficient as a dividend. In fact, a write-off is taxed in exactly the same way, but unlike a dividend it can be done even if your company has no profits.
NI warning
Writing off a debt can trigger NI liabilities as if the amount written off were salary. But they can be avoided where the loan is made to you in your role as a shareholder rather than as a director/employee of your company. Even where NI contributions are payable on a write-off, they would amount to less than the NI payable if using the salary option to clear the debt and the 33.75 % tax. From a tax and NI perspective writing off a loan makes good sense.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.