The Bounce Back loan scheme is fast, attractive and gives small businesses easy access to money. But many unsuspecting SME companies are unaware of a potential 32.5% tax charge if used incorrectly. We look at how this arises and what you can do.
The government introduced Bounce Back Loan scheme on 4 May 2020 to help small businesses get access to a injection of cash up to £50K. As loans, the Bounce Back terms are very attractive: no interest or repayments for the first year, a low interest rate afterwards, and no penalties if you pay them back before the six years are up.
What is the loan used for?
The problem arises when the money is taken out as cash withdrawals to fund private expenses even though the Bounce Back Scheme terms specifically states that it is not for personal purposes.
In these circumstances, as a company, you essentially have two basic options: treat the withdrawal as dividends or treat the withdrawal as a loan owed to the company by the shareholder/director.
In a Coronavirus riddled world, many small companies will not be in a profitable place and hence may not be able to legally declare dividends. In such scenario, to avoid the prospect of “illegal” dividends, the second option kicks in and you are faced with treating the monies withdrawn as a “loan”. Specifically, they become what is known as directors’ loans which is a loan from the company to the director/shareholder. The upshot of this is that you must repay the loan balance to back the company at some point in the future.
Corporation tax charge on loans: 32.5%
And this is where the problems kick in. The Bounce Back loan has very attractive repayment terms, so it is tempting to leave it outstanding beyond the first 12 months. However, loans to directors can be subject to a corporation tax charge at 32.5% if not repaid within a certain time period. This 32.5% tax charge becomes due if you do not repay the director’s loan back to the company within 9 months of the company’s year-end passing. For those withdrawing the full £50,000, the tax charge can amount to an eye watering £16,250! This tax is payable by the company and will no doubt severely impact cashflow.
Can you avoid the 32.5% tax charge?
If you’re planning on taking a loan and repaying it within 9 months of your company accounting year-end (the date in which you actually applied for the BBL loan does not matter here for tax), no corporation tax charge will arise. But, if you end up having to pay the 32.5% tax charge, there is some relief as you can reclaim the tax back from HMRC at a later point when the loan is cleared and under certain circumstances.
Personal tax issue
Also, as if paying 32.5% corporation tax wasn’t enough, there is a potentially a further additional tax on the loan when borrowing money from your company. This occurs when a director’s loan exceeds £10,000 at any point during the year; HMRC treat this as receiving a “benefit in kind”. This can have personal tax implications, including a National Insurance charge for your company. However, to avoid this, the company can charge you interest on the loan at HMRC’s official rate for the duration of the “loan”.
Paying a salary instead
The more straightforward option is to pay yourself a salary. But by doing so you will be essentially taxing the loan via PAYE. This may or may not be cheaper than paying the £16,250 above depending how it is structured.
But remember, Bounce Back Loans are not for personal purposes, and insolvency practitioners (who would presumably act on behalf of banks should you fail to repay the loan) have warned that increasing salary payments after receiving Bounce Back Loans may be treated as a being for personal purposes, although we feel this interpretation may be open to challenge.
If you are considering taking out a Bounce Back Loan and need help with the issues above, please call us on 0114 272 4984 or email firstname.lastname@example.org.