Do you agree these are the right primary objectives for rules governing the taxation of loans from close companies to their participators? Please explain your answer.
We do not consider that the majority of loans provided to participators to be a form of deliberate tax avoidance. Acting for predominantly Owner Managed Businesses (OMBs) you quite rightly state that many of these situations arise because such businesses used to be run as sole traders or partnerships, where the proprietor took drawings.
Whilst the accountants and tax advisers continue to try to educate our clients about the legal status of a company, too many business people believe they and their company are one and the same. Therefore, whilst we accept our responsibility in education, we do not consider this to be in any way deliberate tax avoidance.
Furthermore, even though the businessman or woman taking such “drawings” may believe the funds are theirs, the preparation of the company accounts will correctly classify these as loans. As such the loan can only be cleared by one of three ways. Either repay the loan, pay a dividend or bonus to clear the loan or write off the loan. In all instances either the cash is returned to the company or a suitable tax charge arises. With the existing s455 charge and in many instances a personal benefit in kind, such individuals often end up paying more in tax in the end, hardly tax avoidance.
What, if any, other objectives do you think any reform should seek to address?
The regime needs to also be non-burdensome to administer for tax agents. The majority of OMBs will not prepare the company tax return themselves and it is the tax agents who currently deal with the documentation and reporting in this regard.
Any changes to the system should not increase the administrative burden on tax agents as this results in extra costs to their clients. As indicated above, the present issues are in part caused by a lack of education of the complex system around loans from companies and HMRC should be encouraged to place more emphasis on education and simplification of the systems currently in place for loans rather than on adding to an already complex system.
For each of the options, including the current regime as outlined in Chapter 3, please consider the following questions: a. Would the option be an appropriate and effective deterrent to extractions of value by participators from close companies? Please explain your reasoning.
b. Is the option itself robust against avoidance? Please explain your answer.
c. Does the option inhibit genuine commercial practice? Please provide any real-life examples you have as to why the option could create difficulties.
d. What do you think presents the fairest option, and why?
e. How do you think the option affects administrative burdens for business? Would the administrative burdens be proportionate?
f. How could the option better meet the policy objectives or be improved?
g. Do you think the suggested rates of tax are appropriate? Why (not)?
h. Please identify and explain what you consider to be the strengths and weaknesses of the option.
Option one – maintain the current regime
Whilst maintaining the current regime will not act as a deterrent, this is our preferred option.
Loans to participators, for OMBs and the SME market, are not a form of deliberate tax avoidance. Indeed, steps have already been taken to prevent bed and breakfasting and most loans are usually cleared by way of a dividend or bonus thus increasing the income tax, and, in the case of a bonus, national insurance liabilities to be collected by HMRC.
This remains the fairest option, the rate being aligned to the effective rate of a dividend to the higher rate taxpayer. There must be some benefits administratively for HMRC by having one combined regime for both the benefit in kind and the overdrawn loan account and our view is that this should be explored in greater detail together with an exploration of how the tax payer can be educated about this issues caused. As mentioned below we can see real benefits in extending the disincorporation relief so that those taxpayers who slipped into incorporation because of the lower rates of corporate tax in the past can now move back to a more appropriate business structure.
Option two – increase the tax rate
We do not believe that an increase in the rate will alter, in any significant way, the number of loans to participators. As stated above, this is, in our opinion, not a form of tax avoidance but rather an issue that has arisen due to the difference between corporation tax rates and income tax rates, driving more businesses to become companies.
All this will do is lead to companies, in particular SMEs, having to deposit more funds with HMRC until the loans are repaid. It is neither a deterrent nor good commercially.
Companies will just view an increase in the rate as exactly that and it will not change practice.
This is our second choice option, but not with a 15% increase to the current rate. A rate of 30% to 35% being fairer given that we do not consider this to be deliberate tax avoidance. However, we do feel that this is a poor substitute to option one together with better education and a better disincorporation relief.
Option three - permanent charge which arises annually
We do not consider this to be a fair option. A similar charge already exists being the benefit in kind on loans charged below the official rate of interest. The vast majority of loans to participators will be caught by this charge too. Rather than create a second similar charge, HMRC should ensure it is capturing all the benefits in kind caught by this charge. It would certainly create unfairness if such a system were to be introduced without a substantial period of education from HMRC about the new rules and a period of transition.
Option four – permanent charge which arises annually on average amounts outstanding
As with option three above, we do not consider this to be a fair option given the existence of the benefit in kind charge.
The options do not form an exhaustive list – we would welcome alternative proposals or suggestions as to how the options or current regime could be improved. Are there any other options that may be more appropriate? In setting out your answer please make reference to the points above.
We consider the current regime, together with the recent changes to prevent “bed and breakfasting” to be sufficient.
Are there any other interactions which HMRC should be considering, in particular are there any specific interactions which would render any of the options ineffective or inappropriate?
Yes, the interaction with loans to employees where the interest rate is below the official rate of interest. Given that the minimum limit for such loans to be caught is increasing to £10,000 it seems at odds with this consultation given that many “loans” are caught by both provisions.
One system for such loans would be preferable and easier for the taxpayer to understand.
The new disincorporation relief should be widened to eliminate the personal tax charge in order to encourage some of the micro businesses who struggle with the corporate regime to revert back to sole traders or partnerships.
Do you think any of the reform options impact upon individuals or households? Please explain your answer.
This will affect individual directors who are often the wealth creators in the country. It will affect their personal wealth, and perhaps their wish to invest further.
Do you think any of the reform options raise questions about equality? Please explain your answer.
Sole traders and partners can have overdrawn capital accounts without such adverse taxation measures.
How effective is each of the options at reducing administrative burdens for business? How much time and/or cost would be saved or increased? Please explain your answer.
The proposals may increase the burden on both business and their tax agents, whilst probably not achieving the deterrent HMRC wish this to be. It may also lead to some companies seeking to circumvent the charge, thus actually creating more problems than it is aimed to solve. It is difficult to measure the increase in the costs that we feel these measures will generate except to say that there will inevitably be an increase in costs because of the need to continue to apply two different systems one for the benefit in kind and one for the overdrawn loan account. If the Revenue wishes to reduce the administrative burden then these systems should be combined in someway.
What other (positive or negative) impacts do you think each of the reforms may have? Please explain your answer.
The proposals will be seen as an unnecessary burden on OMBs and SMEs at a time when HMRC should be concentrating on genuine tax evasion and aggressive tax avoidance. This is not deliberate tax avoidance in the vast majority of cases and it needs to be recognised for what it is, a historic problem caused in particular by the 0% and 10% historic rates of corporation tax.
