How can bounce back loans become taxable?

10 August 2020

Bounce back loans (BLL) are great. Small businesses are looking at bounce back loans. What are the benefits of the BBL?

Because they are so easy to apply.  There are no repayments due in the first year. There is no interest in the first year. The interest in years two to five is two and a half percent, really low. Furthermore there are no guarantee, no personal guarantees and no security. So all of that is a really good mix of combinations. It is the easiest and perhaps cheapest loan you can get. If you are not already familiar with the benefits of the Bounce Back Loan then please visit the Government website for full details https://www.gov.uk/guidance/apply-for-a-coronavirus-bounce-back-loan.

In this blog we look at the how the BBL may become taxable. This is only relevant for Limited companies.

It all starts when you use your bounce back loan to subsidize your personal expenditure.

What do we mean by subsidizing personal expenditure?

We all know that owner managed limited companies can keep their business finance and personal finances close together, and that is a worry. When you draw money from a limited company you need to be clear on how this is being accounted in your company accounts. Is it a salary or dividend, or is it a loan repayment from the company, is it a loan from the company?

Lets have a quick look at what this means and how the tax works.

Salary –  most company directors will already be taking a salary from the company anyway. Salaries are taxed at source; the company will pay deduct income tax and employees NI. The company will pay employers NI on top of the salary. Paying employees NI and employers NI (total of 25.8%) is not cheap and makes this a very expensive way to take money from the company.

Dividends – dividends are a profits distribution after tax. The key point here is that the company will have to have suitable reserves (profits after tax within the company) in the company to pay dividends. The recipient of the dividends will pay Income tax on their dividend income via self-assessment tax returns. This is generally tax efficient.

Loan repayment – this is where you have loaned the company money in the first place? Maybe you paid for business expenses from your personal account or gave the business a small loan when you started. The loan repayment is you repaying yourself the loan (money you are owed anyway).

Loan from the company – this is where the company gives you a loan. As a loan is temporary in nature, you will have to repay the company the loan. There are two tax consequences of taking a loan from the company which are interest free loan benefit and s455 tax. The interest free loan benefit is not so drastic, in short if you take a loan of more than £10k from the company then the company will have to charge you interest at the HMRC official rate (currently 2.5%). If the company does not charge you interest you will still be charged income tax on the deemed value of the interest saved via P11d. The s455 tax is a little more tricky and deserves it’s own section.

Section 455 – What it says is this:

If your company lends you money, then you have to pay it back within 9 months of your yearend, if you do not pay it back within 9 months of the  year-end you have to pay a 32.5% tax on the loan outstanding. It is a company tax that you have to pay and that is my concern, that these bounce back loans might creep into people’s personal accounts and then could trigger a Section 455 tax in the company. If you are taking a loan from the company you either need to make sure you pay the loan back to the company within 9 months of the yearend or make sure you leave enough funds in the company to cover the s455 tax due.

The good news is when the loan is repaid to the company then the company will be repaid the s455 tax from HMRC. The S455 tax is more like a tax deposit more than a tax charge. The idea behind the s455 tax is to avoid HMRC missing out on the income tax payable on dividend income had a dividend been paid instead of a loan.

Summary

So hopefully you can see that taking a bounce back loan can create a tax liability if you use the loan for personal expenses or income. Be mindful of the potential tax liability and make sure you leave enough funds and plan for the additional tax charge that may arise. Looking for advise on bounce back loan scheme? Contact us!