Loans released by Close Companies

This measure is designed to prevent a close company claiming a corporation tax deduction when it releases a debt due from a shareholder.

Baker Tilly analysis

If an individual who is a participator in a close company has borrowed from the close company, and the debt is released, the release will generally be taxed as a distribution – for example, as if it were a dividend. Dividends are not deductible for corporation tax purposes but, in most cases, debt releases are. There have been a number of cases recently of close companies claiming a corporation tax deduction when a debt due to a shareholder is released. HMRC clearly regard this as an abuse whereby companies are effectively claiming tax deductions for what amount to dividend payments, so it is not surprising that HMRC have acted to block the corporation tax deduction in such circumstances. The block is effective from Budget Day.

In detail

This measure, effective from Budget Day, acts to block a corporation tax deduction for close companies that release debts due from participators. The definition of a close company is, broadly, a company under the control of five or fewer participators, or its directors. A number of close companies and their shareholders have recently been seeking a tax advantage where debts owed by shareholders to the company are released. The release of such a debt will normally be taxed on the shareholder as a distribution – for example, as if it were a dividend. Arguably, also, the distribution is not liable to NIC.

A dividend is not deductible for corporation tax purposes, but the release of a debt owed by an individual shareholder generally is deductible. HMRC are known to have been unhappy about this, as it has the effect of giving a corporation tax deduction for what amounts to a dividend payment.

This advantage is to be stopped by legislation that will be effective from Budget Day.