Tax relief on loans to close companies
Tax relief on loans to close companies
Family and personal companies are often ‘close’ companies. Broadly, this is one that is controlled by five or fewer shareholders or any number of shareholders all of whom are directors.
In a close company, the directors and shareholders may borrow money from the company (in respect of which a tax charge may arise if the loans are not repaid by the time that the corporation tax for the period in which the loans were made is due nine months and one day after the end of that period).
The directors and shareholders may also lend money to the company. This may be more prevalent over the last 18 months as a result of the Covid-19 pandemic. Where the director borrows money in order to lend it to the close company, tax relief may be available. Tax relief may also be available where a shareholder borrows money to buy more shares in the company.
Availability of interest relief
Individuals are only entitled to tax relief for interest payments on certain loans. The list of eligible loans include a loan to buy an interest in a close company.
An individual can benefit from tax relief if they borrow money to buy ordinary shares in a close company in which they own at least 5% of the ordinary share capital (either alone or with associates). Where the 5% test is not met, relief is available for a loan to buy shares in a close company in which the individuals owns some shares and in which they work for the greater part of their working time in the management and conduct of the company’s business, or that of an associated company.
Tax relief is also available if the individual borrows money to lend it to a close company in which they have an interest, as long as the money is used wholly and exclusively for the purposes of the business or that of an associated company, provided that company is a close company and is not a close investment holding company. Again, to qualify for the relief, the individual must either own 5% of the ordinary share capital (either alone or with associates), or own shares in the company and spend the greater part of their working time working for the company, or an associated company.
The relief is lost if the borrowings are recovered from the close company. This would be the case if, say, a directors borrowed £50,000 to lend to the close company and the company repaid this, but the director did not clear the original loan. In this situation, the director would not be able to continue to claim tax relief on the interest paid on the original loan.
Relief must be claimed
Tax relief on eligible borrowings must be claimed. This can be done via the self-assessment tax return.
The income tax relief cap applies – this is the greater of £50,000 and 25% of adjusted net income.
Can you claim the Employment Allowance for 2021/22?
Can you claim the Employment Allowance for 2021/22?
The Employment Allowance is a National Insurance allowance that enables eligible employers to reduce their employers’ (secondary) Class 1 National Insurance bill by up to £4,000. However, not all employers can benefit – there are some important exclusions.
Eligible employers
To qualify for the Employment Allowance, the employer’s Class 1 National Insurance liabilities for 2020/21 must be less than £100,000. Where the employer is part of a group, the £100,000 limit applies to the group as a whole, not the individual group companies.
The Employment Allowance is not available to companies where the sole employee is also a director. This rules out most personal companies. However, family companies with more than one employee are able to claim.
There are other exclusions too, for example, employers who employ someone for personal, household and domestic work unless the worker is a care or support worker.
Amount of the allowance
The Employment Allowance is set at the lower of £4,000 and the employer’s secondary Class 1 National Insurance liability for the year. Once claimed it is set against the employer’s Class 1 liability until it is used up.
Example
A Ltd is eligible for the Employment Allowance. Its secondary Class 1 National Insurance liability is £1,500 a month. It claimed the Employment Allowance at the start of the 2021/22 tax year. The allowance is used as follows:
Month 1: £1,500 of the Employment Allowance is set against the liability for the month of £1,500, leaving nothing to pay. The remaining Employment Allowance of £2,500 (£4,000 – £1,500) is carried forward.
Month 2: £1,500 of the Employment Allowance is set against the liability for the month of £1,500, leaving nothing to pay. The remaining Employment Allowance of £500 (£2,500 – £1,500) is carried forward.
Month 3: The remaining £500 of the Employment Allowance is set against the liability for the month of £1,500, leaving £1,000 to pay. The Employment Allowance has now been used in full.
Months 4 to 12: The Employment Allowance has been used in full, so the employer’s Class 1 National Insurance liability for the month of £1,500 is payable in full.
Claiming the allowance
The Employment Allowance is not given automatically and must be claimed each year. This can be done through the payroll software, or via HMRC’s Basic PAYE Tools if the payroll software does not have an Employment Payment Summary (EPS) feature.
Although claims can be made at any time in the tax year, the earlier the claim is made, the earlier the employer will start benefiting from the Employment Allowance.
Claims can also be made retrospectively for the previous four tax years if the employer was eligible for the Employment Allowance, but did not claim it.
Personal and family companies – Optimal salary for 2021/22
Personal and family companies – Optimal salary for 2021/22
A popular profit extraction strategy for shareholders in personal and family companies is to pay a small salary and to extract further profits as dividends. The optimal salary will depend on whether the employment allowance is available to shelter any employer’s National Insurance liability that may arise.
Preserving pension entitlement
One of the main advantages of paying a small salary is to ensure that the year remains a qualifying year for state pension and contributory benefit purposes. To qualify for a full state pension on retirement, an individual needs 35 qualifying years.
For the year to be a qualifying year, earnings must be at least equal to the lower earnings limit. A director has an annual earnings limit, and for 2021/22, the annual lower earnings limit is set at £6,240. Where the shareholder is not a director, earnings for each earnings period must be at least equal to the lower earnings limit. For 2021/22, the weekly and monthly thresholds are, respectively, £120 and £520.
Contributions are payable by the employee at a notional zero rate on earnings between the lower earnings limit and the primary thresholds. The employee starts paying contributions once earnings exceed the primary threshold.
Optimal salary – Employment allowance is not available
The employment allowance is not available to companies where the sole employee is also a director. This means that personal companies will generally be unable to claim the allowance.
For 2021/22, the primary threshold is set at £9,558 (£184 per week/£797 per month) and the secondary threshold is set at £8,840 (£170 per week, £737 per month).
Although the maximum salary that can be paid without paying any National Insurance is one equal to the secondary threshold of £8,840 for 2021/22, it is beneficial to pay a higher salary equal to the primary threshold of £9,568. Employer’s National Insurance will be payable on the salary to the extent that it exceeds £8,840 at a cost of £100.46 (13.8% (£9,568 – £8,840)), however, this is outweighed by the corporation tax deduction at 19% on the additional salary and the employer’s NIC.
Once the primary threshold is reached, employee contributions are payable at 12%. At this point, the combined National Insurance cost of 25.8% (13.8% + 12%) is more than the corporation tax saving and paying a salary in excess of the primary threshold is not worthwhile.
Thus, where the employment allowance is not available, the optimal salary is equal to the primary threshold for 2021/22 of £9,568 (£184 per week, £797 per month).
Optimal salary – Employment allowance is available In a family company scenario, the employment allowance will be available if there is more than one employee on the payroll. As long as the employment allowance is available to shelter the employer’s National Insurance that would otherwise arise, the optimal salary is one equal to the personal allowance, set at £12,570 for 2021/22. No National Insurance is payable until the primary threshold is reached. Above this level, employee National
Insurance is payable at the rate of 12%. However, the additional salary saves corporation tax at 19%. However, once the personal allowance has been used, tax at 20% is payable as well as employee’s National Insurance of 12%, which exceed the corporation tax deduction of 19%. Thus, where the employment allowance is available, the optimal salary for 2021/22 is one equal to the personal allowance of £12,570 (£242 per week, £1,048 per month).