Lending to a relative - avoiding the tax trap

Bank of Mum and Dad

In recent years parents are often asked for extra financial help by their children, say to provide a deposit on their first home or to start a business. There can be tax ramifications where the money is provided as a loan on which interest is payable but these are relatively straightforward and we’ll look at them in a separate article. But what if the financial help comes from the parent’s company rather than them personally?

Loans to participators

If a close company (broadly, one that’s owned or controlled by five or fewer individuals) lends money to a participator, typically a shareholder, it can result in a tax bill for the lending company.

The charge only applies if the debt is not repaid within nine months following the end of the accounting period in which the loan was made.

How much tax?

The tax is equal to 33.75% of the debt still owing at the end of the nine-month period. This tax, commonly referred to as a “ s.455 charge ”, will be refunded by HMRC nine months after the end of the accounting period in which the debt is cleared.

The trouble is that a long-term loan such as that envisaged in our scenario leaves the lending company out of pocket for a correspondingly long time.

The s.455 charge not only applies to loans to a participator but also to an “associate” of a participator, e.g. a relative.

Taxing relatives

In context of this scenario, the loan, which will almost certainly be a long-term one, would result in her parent’s company, assuming it’s a close company, having to bear the burden of a s.455 charge. The good news is the charge can be easily avoided.

 If the parent’s company makes the loan not to the daughter but to the daughter’s company, the s.455 charge won’t apply because the companies are not associated. 

Anti-avoidance rule

While a loan between close companies that aren’t associated with each other won’t directly trigger a s.455 charge, an anti-avoidance rule would come into play to impose a charge if, in our scenario, the daughter borrows money from her company. The rules exist to prevent indirect loans escaping the s.455 charge.

The anti-avoidance rule isn’t triggered if the daughter takes money from her company, funded by the loan from her parent’s company, that counts as taxable income. For example, a salary, dividend or benefit in kind.