Introduction Background Note
6.Close companies are defined in section 439 of CTA 2010. In general a company is a close company if it is under the control of five or fewer participators or of participators who are directors. A participator is defined in section 454 of CTA 2010 as “a person having a share or interest in the capital or income of the company”.
7.Special CT rules for close companies aim to address the tax advantages that may arise from the fact that such companies are controlled by its participators. The release of loans made to participators is an example of such an advantage.
8.A participator will normally extract profits from a company by receiving employment income or dividends/distributions.
9.If taken as dividend it is taxed as investment income on the recipient who is entitled to a tax credit. There will be no further income tax liability unless they are a higher rate taxpayer. However, the company receives no CT deduction for the dividend paid.
10.If taken as employment income the participator is charged to income tax with no tax credit. However, the company will receive a CT deduction for the amount paid.
11.Where a company makes a loan to the participator and releases it, the recipient of the released loan is charged to income tax but is treated as having paid income tax at the dividend ordinary rate. As with the receipt of a dividend, there will be no further liability to income tax unless they are a higher rate taxpayer. However, under the CT rules governing corporate debt (the ‘loan relationships’ rules) a loan released will normally give rise to an expense recognised in the company’s accounts and be allowable for corporation tax purposes.
12.This section broadly restores the tax treatment of loans made to close company participators to the position that existed until 2002, when changes were made to the definition of connected party in the loan relationships rules. It does not re-impose the pre-2002 rules on connection, but it does prevent close companies from obtaining a tax deduction for what is in effect a distribution to the participator. It does not change the income tax treatment on the person to whom the released or written off loan was made.