The Association of Taxation Technicians (ATT) has said the Budget announcement of an increase in the tax charged on loans from limited companies to their participators (essentially their shareholders) is not a surprise but that it will mean that the shareholders concerned may need to do some number-crunching.
Without the change there could, from 6 April 2016, have been an incentive on the shareholders of owner-managed companies to borrow money from their companies rather than take dividends.
Michael Steed, President of the ATT, commented:
“From 6 April 2016, higher rate (40 per cent) taxpayers will pay tax on their dividend income at an effective rate of 32.5 per cent instead of the current effective rate of 25 per cent. However, the new ‘tax-free’ dividend allowance of £5,000 which is being introduced from April 2016 needs to be taken into account. In simple terms, the combined effect is that a higher-rate shareholder receiving annual dividend income of more than £21,667 will from 6 April 2016 have a greater income tax liability on their dividend income.
“This might have prompted shareholders to consider the alternative of borrowing money from their company. That (except in the case of very short-term loans) would have involved their company in having to make a loan to HMRC of an amount equal to what would have been 25 per cent of the loan - but yesterday’s announcement increases that rate to 32.5 per cent. So the new announcement maintains the alignment between the effective rate of tax on dividends and the loans to participators charge which is made on companies. In addition, where the shareholder was also a director, they would have an income tax liability on the beneficial loan, currently calculated at three per cent.
“In practical terms, the Budget announcement is likely to mean that shareholders who want to be able to spend what they withdraw from a company without ever having to repay it will see dividend income from their company as more attractive than a loan. By contrast, shareholders who will be in a position to make full repayment may still need to do the arithmetic to see whether a loan might be more advantageous.”