Chapter 6: Release of loan to participator in close company
Section 415: Charge to tax under Chapter 6
1680.This section is based on sections 421(1) and 422(5) and (6) of ICTA. It imposes a charge to tax if a close company lends money to a participator and subsequently releases or writes off all or part of the debt.
1681.“Close company” and “participator” are defined in the interpretative provisions of Part 6 of ICTA (see sections 414 and 417 of that Act). Broadly, a close company is a UK resident company controlled by five or fewer participators (or any number of participators who are also directors of the company). A UK resident company may also be close if on the winding-up of the company more than half of the assets of the company would be distributed to five or fewer participators (or any number of participators who are also directors of the company). “Participator” is given a very wide meaning and includes any person having a share or interest in the capital or income of the company.
1682.Subsection (1) sets out the circumstances giving rise to the charge to tax. The expressions “releases”, “writes off”, “debt”, “loan” and “advance” have been preserved from the source legislation. There is no compelling reason to change any of these words and they need to be preserved to maintain the link with section 419 of ICTA.
1683.The tax charge under subsection (1) is subject to section 418 (seesubsection (2)). This prevents double taxation under this Chapter and Chapter 5 of Part 5 of this Act.
1684.Subsections (3) and (4) rewrite section 422(5) and (6) of ICTA. If a loan is made by a company (“B”) which is controlled by a close company (“A”), in circumstances where section 419 of ICTA would not otherwise apply, section 422(1) of ICTA treats the loan as made by A (so section 419 of ICTA applies). If B releases or writes off the loan, section 422(5) of ICTA effectively treats A as having released or written off the loan (so section 421 of ICTA applies). Further, section 419(2) of ICTA gives “loan” an extended meaning. So, if a person incurs a debt to a close company or a debt due from a person to a third party is assigned to a close company, the close company is treated as having made a loan. This extended meaning of loan is applied to B by section 422(6) of ICTA.
Section 416: Income charged
1685.This section sets out the amount charged to tax and is based on section 421(1) of ICTA.
Section 417: Person liable
1686.This section states who is liable for any tax charged.
1687.Subsection (1) explains that it is the person to whom the loan or advance was made unless that person has died or the loan or advance was made to trustees of a trust which has come to an end (subsection (2)).
1688.There is no reference, here or in the source legislation, to the position where the burden of the debt has been passed to a third party. This is because it is not possible in law for a debtor to assign a debt. Any transfer of debt must be made by way of novation, which would involve the existing debtor being released from the debt and the new debtor taking on a new debt. In such a case, therefore, a charge to tax under section 421 of ICTA would arise on the release of the existing debtor. The interpretation is based on the cases of Collins v Addies and Greenfield v Bains (1992), 65 TC 190 CA(15).
Section 418: Relief where borrowers liable as settlors
1689.This section is based on sections 421(3) and 677(3) of ICTA. Together these provisions prevent double taxation on the release or writing off of a loan where a sum in respect of the loan is treated as the borrower’s income in his or her capacity as settlor of a settlement.
1690.Section 677 of ICTA charges a settlor to income tax where the trustees of the settlement directly or indirectly make a capital payment to the settlor. A charge to income tax is only made if, and to the extent that, the payment can be matched against income retained within the settlement.
1691.So, it is possible that in respect of a particular tax year the borrower is liable to income tax in his or her capacity as settlor on a sum in respect of a loan and is also liable to tax under section 421 of ICTA in respect of amounts released or written off. Likewise, it is possible that the borrower has been liable to income tax in an earlier tax year in his or her capacity as settlor on a sum in respect of a loan or under section 421 of ICTA in respect of amounts released or written off.
1692.Section 421(3) of ICTA provides relief for sums which fall to be included as income under section 677 of ICTA. It suggests that section 677 of ICTA takes precedence:
“This section shall not have effect in relation to a loan or advance made to a person if any sum falls in respect of the loan or advance to be included in his income by virtue of section 677, except so far as the amount released or written off exceeds the sums previously falling to be so included (without the addition for income tax provided for by subsection (6) of that section).”
1693.But section 677(3) of ICTA provides:
“Where any amount is included in a person’s income by virtue of section 421 in respect of any loan or advance, there shall be a corresponding reduction in the amount (if any) afterwards falling to be so included in respect of it by virtue of this section.”
1694.This suggests that section 421 of ICTA takes precedence.
1695.The purpose of these provisions (which were introduced in the same Finance Act) is to prevent the same sum being taxed both under section 421 of ICTA and section 677 of ICTA. It is believed that “afterwards falling to be so included” in section 677(3) of ICTA is a reference to later tax years. So, for the purposes of section 677 of ICTA amounts charged in earlier tax years under section 421 of ICTA will be taken into account, but within the same tax year section 677 of ICTA will take precedence. This would mean that “previously falling to be so included” in section 421(3) of ICTA would include amounts charged to tax under section 677 of ICTA in the same and earlier tax years.
1696.So section 418:
makes it clear that section 677 of ICTA (rewritten as section 633 of this Act) takes precedence over section 421 of ICTA; and
ensures that the same sum is not taxed twice.
1697.Subsections (2) to (6) set out the steps to be taken to determine whether tax is charged under section 415. In particular, subsections (2) and (3) require the “total amount previously charged” (that is, sums taxed under section 633 of this Act either in previous tax years or in the same tax year and amounts taxed under this Chapter) to be compared with the “total amount released”. Only if the total amount released exceeds the total amount previously charged, is tax charged under this Chapter.
1698.Any amount that is charged to tax under section 415 is grossed up at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) in the usual way (see subsection (3)).
1699.Subsection (5) provides that, when calculating the amount that has already been charged under section 633of this Act, only the net amount is taken into account, not the amount produced by the grossing up required under section 640(1) of this Act.
Section 419: Loans and advances to persons who die
1700.This section deals with who is liable for any tax charged where the original debtor has died and the loan is released or written off during the administration of the estate, or at some later point. It is based on section 421(2) of ICTA.
1701.If the conditions in subsection (1) are met, subsection (2) confirms that there is no charge under section 415. Instead, the amount that would have been charged under that section is treated as forming part of the aggregate income of the estate and may be charged under Chapter 6 of Part 5 of this Act or section 701(8) of ICTA.
1702.If subsection (2) does not apply,subsection (3) will (so that tax is charged under this Chapter).
Section 420: Loans and advances to trustees of trusts that have ended
1703.This section is based on section 421(2) of ICTA and applies where a loan has been made to trustees of a trust and the loan is released or written off after the trust has come to an end.
Section 421: Income tax treated as paid
1704.This section explains how a person’s income tax liability is satisfied (in whole or in part). It is based on section 421(1)(b) of ICTA.
1705.Under subsection (1), the person liable is treated as having paid income tax at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on the gross amount released or written off.
1706.If the debt is released or written off during the administration of a deceased person’s estate, the personal representatives are not charged to tax under this Chapter but the amount of income that would otherwise be so charged forms part of the aggregate income of the estate for the purposes of Chapter 6 of Part 5 of this Act or section 701(8) of ICTA. As personal representatives are not charged to tax under this Chapter they are not “persons liable”. This means that they are not treated as having paid income tax under this section (but see the commentary on section 680). “Personal representatives” is defined in section 878 of this Act.
1707.Subsection (2) provides that the tax treated as paid is not repayable. This applies even if the person is a non-taxpayer.
1708.Subsections (3), (4) and (5) ensure that an individual cannot be given credit for income tax on more than the amount of the loan released or written off which is charged to tax.
1709.Section 421(1)(c) of ICTA deals with tax rates and treats the amount charged to tax as not brought into charge to tax for the purposes of sections 348 and 349 of ICTA. Section 421(1)(c) of ICTA is not rewritten in this Chapter. But rather than leaving it “stranded” in section 421 of ICTA it is rewritten in amendments to sections 1A of ICTA and 348 and 349 of ICTA (see paragraphs 3 and 147(3) of Schedule 1 to this Act respectively).
STC [1991] 445; STC [1992] 746
