Category: Finance & Accounting

It is easy to fall into the trap of assuming that legal and professional costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story.  

Legal and professional fees – Capital or revenue?

At some point, a landlord is likely to incur legal and professional fees in connection with the running of their property rental business. It is easy to fall into the trap of assuming that these costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story. The landlord must also determine whether the costs are revenue or capital in nature. The rules also differ depending upon whether the accounts are prepared on the cash basis or using traditional accounting under the accruals basis.

The rule

The nature of the legal fees follow that of the matter to which they relate – so if the fees are incurred in relation to an item which is itself revenue in nature, the legal and professional fees are also revenue in nature. Likewise, legal fees that are incurred in connection with a matter that is capital in nature are also capital in nature.
Legal fees that are revenue in nature would include, for example, fees incurred to recover unpaid rent, while legal fees that are capital in nature would include fees incurred in connection with the purchase of a property.

Cash or accruals basis

Revenue items are deductible in computing profits regardless of whether they are prepared under the cash or accruals basis, although the time at which the relief is given will differ. Under the cash basis, the deduction is given for the period to which the expenditure relates, for the cash basis the deduction is given for the period for which the expenditure is incurred.
For capital expenditure different rules apply. No deduction is allowed for capital expenditure under the accrual basis, whereas under the cash basis, the treatment depends on the nature of the item – capital expenditure is deductible under the cash basis unless the expenditure is of a type for which a deduction is expressly forbidden. Items of the forbidden list include expenditure in or in connection with lease premiums and the provision, alteration or disposal of land (which includes property).

Example of allowable revenue items

A deduction for legal and professional fees will normally be allowed where they relate to:
• costs of obtaining a valuation
• normal accountancy costs incurred in preparing accounts of the rental business and agreeing the tax liabilities
• costs of arbitration to determine the rent
• the costs of evicting an unsatisfactory tenant to re-let the property

Example of capital expenses

The following are examples of legal and professional fees which are capital in nature:
• legal costs incurred in acquiring or adding to a property
• costs in connection with negotiations under the Town and Country Planning Act
• fees incurred in pursuing debts of a capital nature, such as the proceeds due on sale

Leases

Leases can be tricky. The expenses incurred in connection with the first letting or subletting for more than one year are deemed to be capital and therefore not deductible – this would include the legal fees incurred in drawing up the lease, surveyors’ fees and commission. However, if the lease is for less than one year, the associated expenses can be deducted. Normal legal and professional fees on the renewal of a lease are also deductible if the lease is for less than 50 years; although any proportion of the fees that relate to the payment of a premium are not deductible.
If a new lease closely follows the previous lease, a change of tenant will not render the associated fees non-deductible. However, if the property is put to other use between lets, or a long lease, say, replaces a short lease, the associated costs will be capital and non-deductible.

Partner note: HMRC’s Property Income Manual PIM 2120

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Renting out a property at a rate below the commercial level might sound like a great idea – but it might cost you dearly if you try to seek tax relief for your expenses!

Properties not let at a commercial rent

There may be a number of reasons why a property is occupied rent-free or let out at rent that is less than the commercial rate. This may often occur where the property is occupied by a family member in order to provide that person with a cheap home. For example, a parent may purchase a house in the town where their student son attends university and let it to the student, and maybe even his housemates, at a low rent to help them out. While the parents’ motives are doubtless philanthropic, their generosity may cost them dearly when it comes to obtaining relief for the associated expenses.

Wholly and exclusively rule

Expenses can only be deducted in computing taxable rental profits if they are incurred wholly and exclusively for the purposes of the property rental business. Unfortunately, HMRC take the view that unless the property is let at full market rent and the lease imposes normal conditions, it is unlikely that the expenses are incurred wholly and exclusively for business purposes. So, where the property is occupied rent-free, there is no tax-relief for expenses.

If the property is let at a rent that is below the market rent, a deduction is permitted, but this is capped at the level of the rent received from the let. This means that where a property is let at below market rent, it is not possible for a rental loss to arise, or for expenses in excess of the rent to be offset against the rent received from other properties in the same property rental business.
Periods between lets

Where there are brief periods where the property is occupied rent-free or let out cheaply, it may be possible to obtain full relief for expenses. For example, if the landlord is actively seeking a tenant and a relative house sits while it is empty, relief will not be restricted as long as the property remains genuinely available for letting. In their guidance HMRC state, that ‘ordinary house sitting by a relative for, say, a month in a period of three years or more will not normally lead to loss of relief’. However, if a relative takes a month’s holiday in a country cottage, relief for expenses incurred in that period will be lost.

Commercial and uncommercial lets

Where a property is let commercially some of the time and uncommercially at other times, expenses should be apportioned on a just and reasonable basis between the commercial and non-commercial lets. Any excess of expenses over rents in the period when commercially let can be deducted in the computing the profit for the rental business as a whole. However, an excess of expenses over rent when the property is let uncommercially are not eligible for relief.
Timing must also be considered – expenses relating to uncommercial lets cannot be deducted simply because they are incurred when the property is let commercially.

Partner note: HMRC Property Income Manual PIM 2130.

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This blog explains what qualifies for relief for finance costs, the limit on eligible borrowings, and how capital repayments work with a quick example.

Allowable finance costs

Although the way in which landlords obtain relief for finance costs on residential properties is changing, there is no change to the type finance costs that are eligible for relief.

What qualifies for relief

The basic rule is that relief is available for expenses that are incurred wholly or exclusively for the purposes of the property rental business, and this rule applies equally to finance costs. Relief is available for eligible finance costs where they meet this test.

The definition of finance costs includes mortgage interest and interest on loans to buy furnishing and suchlike. Relief is also available for the incidental costs of obtaining finance, as long as the interest on the loan is allowable. Incidental costs of loan finance include items such as arrangement fees, and fees incurred when taking out or repaying loans or mortgages.

Limit on eligible borrowings

A landlord can obtain relief for the costs of borrowings on a loan or mortgage up to the value of the property when it was first let. Buy-to-let mortgages are often more expensive than residential mortgages with interest charged at a higher rate. The loan does not have to be secured on the let property. Where a landlord wishes to buy a rental property and has sufficient equity in their own home, it may make commercial sense to release capital from the home by borrowing against it and using the money to purchase the rental property. Interest on the loan is eligible for relief, despite the fact the loan is not secured on the rental property.

No relief for capital repayments

Capital repayments, such as the capital element of a repayment mortgage or loan repayments, are not eligible for relief. Where the borrowings are in the form of a repayment mortgage, it will be necessary to split the payment between the interest and capital when working out the relief. The lender should provide this information on the statement.

Example

Mervyn wishes to invest in a buy to let property. As he only has a small mortgage on his home, he remortgages to release £150,000 of equity.
Following the remortgage, he has a mortgage of £200,000 on his own home. Using the released equity, he buys a property to let for £150,000. He spends some time renovating the property in his spare time before letting it out. When the property is first let, it has a value of £160,000.

During the 2019/20 tax year, Mervyn pays mortgage interest of 10,000and makes capital repayments of £10,800. The property is let throughout.
Mervyn can claim relief for 80% of the interest costs – this is attributable to the borrowings of £160,000 (80% of the loan of £200,000), being the value of the let property when first let. The interest eligible for relief is therefore £8,000 (80% of £10,000). For 2019/20, 25% (£2,000) is relieved by deduction with the balance giving rise to a deduction from the tax due of £1,200 (75% x £8,000 x 20%).

No relief is available for the capital repayments.

Partner note: ITTOIA 2005, ss. 272A, 272B, 274A, 274B

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In essence, it’s all about the ‘wholly and exclusively’ test – could it be time to invest in some branded sweatshirts?

Dual purpose expenditure – can landlords claim a deduction?

Landlords are able to claim tax relief for expenses that are incurred wholly and exclusively for the purposes of the property rental business. However, some expenses have both a private and a business element. Where this is the case, is any relief available?

Business element separately identifiable

If it is possible to separate the business and the private expenditure, a deduction can be claimed for the business element. This may be the case, for example, in relation to a car which is used for both private journeys and for the purposes of the property rental business, to visit tenants or to check on the properties. Likewise, a landlord may use his or her mobile phone for private calls and also for business calls. From the call log, it will be possible to identify the business calls and to apportion the bill between business and private calls.

Business element cannot be separately identified

If the expenditure is dual purpose in nature and it is not possible to identify the business element, no deduction is allowed. The expenditure does not meet the ‘wholly and exclusively’ test, and as such is not deductible in computing the profits of the property rental business. An example of expenditure that may fall into this category is clothing, even if only worn for working in the property rental business. The clothing fails the wholly and exclusively test as it also provides the landlord with warmth and decency (a private purpose). However, it should be noted that a deduction is allowed for clothing that bears a conspicuous advert for the business, such as a sweatshirt featuring the name of the property rental business and the logo.

Example

Dave is a landlord and has a number of properties that he rents out to students. He uses the same car for the purposes of the property rental business as for private journeys.

Dave undertakes the decorating and much of the maintenance on the properties himself. He has purchased overalls specifically for this purpose, which he wears only when undertaking work on the let properties. In the tax year, he spends £80 on overalls.

In the tax year in question, Dave drove 6,800 miles of which 4,200 were for the purposes of his property rental business.

A deduction is allowed for the business mileage. Dave uses the simplified mileage system, claiming a deduction of £1,890 (4,200 miles @ 45p per mile).

However, although he only wears the overalls when working on his let properties, the private benefit cannot be distinguished from the business use. Consequently, the ‘wholly and exclusively’ test is not met, and the £80 which Dave spent on overalls cannot be deducted in computing the taxable profit for his property rental business.

Partner note: ITTOIA 2005, s, 34.

 

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In this blog we set out the three conditions property must meet to be considered a furnished holiday let and to access all the advantages they bring, and top tip – letting to family or friends at a reduced rate doesn’t count! 

Many Airbnb lets are used as holiday accommodation. From a tax perspective, furnished holiday lettings enjoy some tax advantages over other lets. So, is it possible for an Airbnb let to benefit from these advantages and what conditions must be met?

Qualifying conditions

Simply letting a property as furnished holiday accommodation is not in itself sufficient to qualify for the furnished holiday letting (FHL) treatment. As with other lets, Airbnb lets must meet the conditions set out in the legislation.

The first point to note is that the FHL treatment is only available to properties which are in the UK or the EEA and which are let furnished.

Occupancy conditions

There are three occupancy conditions which must be met for a property to be treated as FHL.

Condition 1 – the pattern of occupancy condition

The pattern of occupancy condition is met if the total of all lettings in the tax year exceeding 31 days is 155 days or less. The nature of holiday letting is multiple short lets rather than longer lets and this condition seeks to recognise this.

Condition 2 – the availability condition

To meet this condition the accommodation must be available for letting for at least 210 days in the tax year. Days where the owner stays in the property do not count as days when the property is available for letting.

Condition 3 – the letting condition

The letting condition is met if the property is let commercially as furnished accommodation to the public for at least 105 days in the tax year. Only commercial lets count towards this total – any days when the property is let to family or friends at a reduced rate or where they are allowed to use the property for free are ignored.

Longer term lets of more than 31 days are also ignored (unless a let which was supposed to be less than 31 days is extended due to unforeseen circumstances, such as a delayed flight or the holidaymaker becoming ill).

Averaging election

If a person has more than one property let as holiday accommodation (whether via Airbnb or similar or otherwise), an averaging election can be made where the letting condition of 105 days is not met. As long as the average let across all properties is at least 105 days in the tax year, the condition is treated as met. Thus, if a person has three holiday properties which were let commercially for periods of 31 days or less for at least 315 (3 x 105) days in the year, the average let would pass the test.

Period of grace election

A second election, a period of grace election, can be made if the landlord genuinely intended to meet the letting condition but was unable to do so, as long as the condition was met in the previous tax year. This will allow the property to continue to be treated as a FHL. If the condition is not met the following year, a second period of grace election can be made. However, if the condition is not met in the fourth year after two consecutive period of grace elections, the property will no longer qualify as a FHL.

Advantages

Qualifying as a FHL offers a number of advantages. It opens the door to various capital gains tax reliefs for traders, including entrepreneurs’ relief. The landlord is also eligible to claim plant and machinery capital allowances if the cash basis is not used. Profits also count as earnings for pension purposes.

Partner note: ITTOIA 2005, Pt. 3, CH. 6 ss. 322 – 328B).

 

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Property Tax

Landlords – you must file your self-assessment tax return by 31 January 2020 to avoid a late filing penalty. Here’s what you need to know:

The self-assessment deadline is looming. Self-assessment tax returns for the year to 5 April 2019 must be filed online by 31 January 2020 if a late filing penalty is to be avoided.

Landlords will need to complete the property income pages. Particular care should be taken where the landlord has a loan or a mortgage as the way in which relief is given for financing costs is changing and the position for 2018/19 is different to that for 2017/18.

The way in which relief for finance costs is given is moving from relief by deducting the finance costs when computing profits to giving relief in the form of a basic rate tax reduction. The 2018/19 tax year is a transitional year.

What costs are eligible for relief?

Interest payable on loans to buy land or property which is used in the rental business is eligible for relief, as is interest on loans to fund improvements or repairs. It should be noted that it is not necessary for the loan to be secured on the let property – the rule is that interest is allowable on borrowings up to the value of the property when first let. Thus, if a landlord borrowed against their main home to fund a buy-to-let investment property, the interest on that loan would be allowable on the loan up to the value when the property was first let. If the mortgage on the residential property is more, the allowable interest is proportionately reduced.

Relief is also available for the costs of getting a loan.

It should be noted that it is only the interest and other finance costs which qualifies for relief – no relief is available for any capital repayments which may be made.

The position for 2018/19

For 2018/19, relief for 50% of eligible finance costs is given as a deduction in computing the profits of the property rental business and relief for the remaining 50% is given as a basic rate tax reduction. This makes completing the property pages of the tax return slightly tricky as the information must go in two places.

The first box which needs to be completed is Box 26. This is where allowable loan interest and other financial costs need to be entered. Amounts entered in this box are deducted in computing rental profits. Therefore, as only 50% of the allowable finance costs for 2018/19 are relieved in this way, only 50% of the costs for that year should be entered in this box.

The remaining 50% is entered in Box 44, helpfully titled ‘Residential finance costs not included in box 26’. The amount entered in this box is used to calculate a reduction in the landlord’s tax bill. The reduction is equal to 20% (the basic rate of income tax) of the amount entered in Box 44.

If you have any unrelieved finance costs from earlier years, these should be entered in Box 45. Any balance of residential finance costs which is unrelieved may be carried forward to future years for relief by the same property business.

Partner note: Self-assessment UK Property notes (SA105); see www.gov.uk/government/publications/self-assessment-uk-property-sa105.

 

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As business owners we all want to make sure our company is a great place to work. Have you considered giving your employees or even their family members educational scholarships?

Partnership rather than a limited company. We explain why in today’s blog.

Employer-funded scholarships

Special tax rules apply to scholarships, which include exhibitions, bursaries or other similar education endowments.

Provided certain conditions are met, there will be no tax or reporting implications where an employer funds a ‘fortuitous’ scholarship for an employee’s family member. Broadly, this means that there must be no direct connection between the employee working for the employer and their family member getting the scholarship.

A scholarship is ‘fortuitous’ if all the following apply:

  • the person with the scholarship is in full-time education
  • the scholarship would still have gone to that person even if their family member did not work for the employer
  • the scholarship is run from a trust fund or under a scheme
  • 25% or fewer of the payments made by the fund or scheme are for employment-linked scholarships

If the scholarship does not qualify for exemption, the employer must report it to HMRC on form P11D and pay Class 1A NICs on the cost of providing it.

Unfortunately, in a family company, directors’ children are unable to take advantage of this provision because the tax legislation deems there to be a benefit in kind. However, in some circumstances a remoter relative (for example a grandparent) could establish such a scheme provided that the student was validly employed and their parents are not involved with the company.

Sandwich courses

An employee in full-time employment may leave that employment for a period to attend an educational establishment but continue to receive payments from their employer, for example where the employee is on a ‘sandwich’ course. Such payments will be treated as exempt from income tax, provided the following conditions are satisfied:

  1. The employer must require the employee to be enrolled at the educational establishment for at least one academic year and to attend the course for at least 20 weeks in that academic year. If the course is longer, the employee must attend for at least 20 weeks on average, in an academic year over the period of the course.
  2. The establishment must be a recognised university, technical college or ‘similar educational establishment’, open to the public and offering more than one course of practical or academic instruction.
  3. The payments must not exceed a specified maximum figure for the academic year. This figure must include lodging, subsistence and travel allowances but does not include any tuition fees payable to the establishment by the employee. Note that:
  • the exemption can apply to payments of earnings payable to the student for periods spent studying at the educational establishment
  • it cannot, however, cover payments made for any periods spent working for the employer, whether during vacations or otherwise
  • the current maximum figure is £15,480 per academic year
  • in principle, the limit is all or nothing: if it is breached then the whole amount is taxable. However, if an increased payment is made during the academic year then this does not invalidate earlier payments made within the agreed limit

Qualifying payments will also be exempt for Class 1 National Insurance Contributions purposes.

Example

Jack’s employer pays for him to attend college on a course that starts in September 2018 and finishes at the end of the academic year in June 2019. Jack works for his employer over the Christmas and Easter periods, during which he is paid his normal monthly salary. His income while working during holidays will be subject to tax and Class 1 NICs, because the exemption only applies to income when attending college.

Jack’s employer pays him £3,000 in September 2018 for the first term of the academic year followed by two further payments of £3,000 each in January 2 and April 2019 to cover terms 2 and 3. These three amounts of £3,000 each will be exempt from tax and NICs because they meet the qualifying conditions, including being less than the financial ceiling of £15,480.

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In many cases, an LLP is likely to be more attractive to those who would have formed a partnership rather than a limited company. We explain why in today’s blog.

Weighing up LLPs

A limited liability partnership (LLP) is similar to an ordinary partnership in that a number of people or limited companies join together and share the costs, risks, and responsibilities of the business. They also take a share of the profits and pay income tax and NICs on their share of the partnership profits.

However, an LLP differs from an ordinary partnership in that its debt is usually limited to the amount of money each partner invested in the business and to any personal guarantees given to raise business finance. Therefore, members have some protection if the business runs into difficulties because their liability is restricted in general terms to the level of their investment.

So, what other advantages can an LLP as a trading vehicle offer?

Advantages

Along similar lines to a company, an LLP is a separate legal person, meaning that the members are not personally or jointly liable for the LLP’s debts, and all contracts are between the LLP and its clients or third parties. If the LLP becomes insolvent, a member’s personal liability is normally limited to the amount of their agreed capital contribution plus the value of any personal guarantee. However, where negligence is involved, members may be personally liable to the full extent of their assets if they have assumed personal responsibility for the advice or work.

The separate legal entity status also means that there is no need, for example, to transfer legal title to property on a change of membership. LLPs also have unlimited capacity and can enter into contracts and hold property in the same way as an individual.

Members of the LLP are usually taxed as if they were partners and not employees or directors. They are therefore not liable to pay PAYE or Class 1 NICs.

Businesses often find it easier to recruit new members to an LLP than to an ordinary partnership, where the prospect of unlimited liability can be a major disincentive to potential partners.

Disadvantages

The benefits of limited liability combined with a favourable tax treatment should not be underestimated, but they do come at a price, most notably the associated disclosure obligations.

Where the LLP’s profit before members’ remuneration exceeds £200,000, there is a requirement to report the amount of profit attributable to the highest paid member (but not their name). Other disclosure includes total members’ remuneration, total members, average members’ remuneration and related party transactions.

There will be costs to set up the LLP and ongoing filing fees. The administrative costs in notifying clients and suppliers and transferring bank accounts, leases and agreements will need to be considered.

Corporate-type accounts have to be prepared, circulated to each member and filed on a public register within nine months of its year end. LLP accounts must comply with UK generally accepted accounting principles and other specific regulations.

Loans and debts due to members (the equivalent of partnership current accounts), are required to be shown as liabilities rather than as part of capital alongside the partnership capital accounts. This in turn reduces the LLP’s net worth and may affect its credit rating and borrowing capacity.

In relation to tax matters, the following areas will need careful thought:

  • tax relief for losses in trading LLPs is restricted
  • there will be no scope for tax-efficient share incentives for staff as there are with a company
  • anti-avoidance provisions may apply to ‘disguised employment’ situations

Weighing up the pros and cons, in many cases, an LLP is likely to be more attractive to those who would have formed a partnership rather than a limited company, but who ultimately seek the benefit of limited liability.

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Generally, tax relief is available, but the rules are different if you’re a small business using the cash basis…

Tax relief on business-related loans

Subject to certain conditions and restrictions, tax relief will generally be available for interest paid on loans to, or overdrafts of, a business in the form of a deductible expense. Different rules for loan interest relief apply to smaller businesses using HMRC’s cash basis for income tax purposes (see below).

One of the main qualifying conditions for the deduction is that the interest must be paid wholly and exclusively for the purposes of the business and at a reasonable rate of interest. Tax relief is only available on interest payments – the repayment of the capital element of a loan is never tax-deductible.

Where only part of a loan satisfies the conditions for interest relief, only a proportion of the interest will be eligible, for example, interest payable in respect of, say, a car used partly for business and partly for private purposes will be apportioned accordingly. Note, however, that tax relief is not available for an employee using a privately-owned car for the purposes of his or her employment, although tax-free business mileage payments may usually be claimed.

A deduction cannot be claimed for notional interest that might have been obtained if money had been invested rather than spent on (for example) repairs.

In addition, a deduction will not be allowed if a loan effectively funds a business owner’s overdrawn current/capital account.

Anti-avoidance rules exist to prevent tax relief on loan interest paid where the sole or main benefit to the payer from the transaction is to obtain a tax advantage.

Incidental costs

In addition to loan interest relief, the incidental costs of obtaining loan finance, such as fees, commissions, advertising and printing, will also be deductible in most cases. The deduction for incidental costs is given at the same time as any other deduction in computing profits for income tax purposes.

Cash basis

From 2013/14 onwards, eligible unincorporated small businesses may choose to use the cash basis when calculating taxable income, and all unincorporated businesses have the option to use certain flat-rate expenses when calculating taxable income.

The general rule for businesses that have chosen to use the cash basis is that no deduction is allowed for the interest paid on a loan. This is however, subject to a specific exception. Where the deduction for loan interest would be disallowed under this general rule or because (and only because) it is not an expense wholly and exclusively for the trade, a deduction is allowed of up to £500.

This £500 limit does not apply to payments of interest on purchases, provided the purchase itself is an allowable expense, as this is not cash borrowing. However, if the item purchased is used for both business and non-business purposes, only the proportion of interest related to the business usage is allowable.

If a deduction is also claimed for the incidental costs of obtaining finance, the maximum deduction for both these expenses together is £500.

If a business has interest and finance costs of less than £500 then the split between business costs and any personal interest charges does not have to be calculated.

Businesses should review annual business interest costs – if it is anticipated that these costs will be more than £500, it may be more appropriate for the business to opt out of the cash basis and obtain tax relief for all the business-related financing costs.

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Be careful when borrowing money from your company as a director – you might fall foul of the ‘bed and breakfasting’ scenario

Directors’ loans – Beware of ‘bed and breakfasting’

It can make sense financially for directors of personal and family companies to borrow money from the company rather than from a commercial lender. Depending on when in the financial year the loan is taken out, it is possible to borrow up to £10,000 for up to 21 months without any tax consequences. However, if the loan remains outstanding beyond a certain point, tax charges will apply.

Company tax charge

In the event that a loan made to a director of a close company in an accounting period remains outstanding on the date when the corporation tax for that period is due, the company must pay a tax charge (‘section 455 tax’) on the outstanding value of the loan. The trigger date for the charge is the corporation tax due date of nine months and one day after the end of the accounting period. The amount of section 455 tax is 32.5% of loan remaining outstanding on the trigger date.

Traps to avoid

In days of old, it was relatively simple to prevent a section 455 charge from applying by clearing the loan balance just before the trigger date and, if the director still needed the loan, re-borrowing the funds shortly after the trigger date (bed and breakfasting). However, anti-avoidance provisions mean that as a strategy this is no longer effective.

Trap 1 – The 30-day rule

The 30-day rule comes into play where, within a period of 30 days of making a repayment of £5,000 or more, the director re-borrows money from the company. The rule effectively renders the repayment in-effective up to the level of the funds that are re-borrowed. Section 455 tax is charged on the lower of the amount repaid and the funds borrowed within a 30-day window.

Example

John is a director of his personal company J Ltd. The company prepares accounts to 31 January each year. In May 2018, John borrowed £8,000 from the company. On 28 October 2019, he repays the loan with money lent to him by his wife. On 7 November 2019, he re-borrows £7,000 from the company to enable him to pay his wife back. He does not make any further borrowings in November 2019.

Corporation tax for the year to 31 January 2019 is due on 1 November 2019. Although the director’s loan is not outstanding on that date, the 30-day rule bites and only £1,000 of the repayment made on 28 October 2019 is effective — £7,000 of the £8,000 paid back is re-borrowed within 30 days. Consequently, the section 455 charge applies to £7,000 – the lower of the repayment and the funds borrowed within 30-days of the repayment – and the company must pay section 455 tax of £2,275 (32.5% of £7,000).

Avoiding the trap

The 30-day rule can be avoided if the company pays the director a dividend, bonus or any other payment that’s taxable and this is used to repay part or all of a loan. In this situation, it’s OK to take another loan from the company within 30 days without the anti-avoidance rule being triggered. Keeping repayments and re-borrowings below £5,000 will also prevent the 30-day rule from biting.

Trap 2 – Intentions and arrangements rule

The ‘intention and arrangements’ rule applies where the balance of the loan outstanding immediately before the repayment is at least £15,000, and at the time a loan repayment is made there are arrangements, or an intention, to subsequently borrow £5,000.

This rule applies even where the new borrowing is outside 30 days. The rule bites if the repayment is made with the intention of redrawing at least £5,000 of the payment, irrespective of when this is done. Again, the rule does not apply to funds extracted by way of a dividend or bonus as these are within the charge to income tax.

Plan repayments carefully

Where looking to repay loans to prevent a section 455 charge from arising, these should be planned carefully to avoid falling foul of the traps.

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