If you have borrowed money from your company, HMRC could be getting in touch!
If you’re a company director and you’ve ever borrowed money from your own business and that loan was later written off, there’s something important you need to know.
HMRC is now writing to directors whose loans may not have been reported properly on their personal tax returns. These letters relate to loans that were outstanding and then written off between 6 April 2019 and 5 April 2023. While the letters are addressed to individuals, the implications can quickly extend beyond the director’s personal tax affairs and affect the company too.
Even if you haven’t received a letter, this is a good moment to stop and ask: Are your director loans fully tax-compliant?
Why director loans matter to HMRC
Director loans are more than just internal transactions. If you’ve taken money out of the business and not repaid it, HMRC may treat that loan in the same way as income, and tax it accordingly. This can result in extra income tax for the individual, and potentially, additional charges for the company.
The concern for HMRC is that loans could be used to avoid income tax, especially if they’re never repaid. That’s why loans that are eventually written off, meaning the company no longer expects to get the money back, are now under much closer scrutiny.
Interest-free loans? There could be a tax charge
If a company lends money to a director without charging interest or charges below the official interest rate, it can create a taxable benefit for the individual which needs to be reported.
The director is usually responsible for any income tax that arises, while the company will have to pay Class 1A National Insurance. This is typically reported via a P11D form each year.
When a loan is written off, it can be treated as income
If a company releases a director’s loan, that amount can be taxed as if it were earnings. This brings a different set of tax obligations, including Class 1 National Insurance, which is paid through the payroll by both the director and the company.
However, if the company is classed as a ‘close company’ (one controlled by five or fewer people), and the director is also a shareholder, the written-off loan may be treated as a dividend rather than a salary. That could mean a lower tax rate for the director, but the distinction isn’t always clear-cut. Whether the loan is taxed as salary or as a dividend depends on the reason it was written off and the individual circumstances, and HMRC looks closely at this.
The Hidden Company Charge: Section 455 Tax
On the company side, there is a separate issue to consider. When a close company lends money to a director or shareholder and the loan isn’t repaid within nine months of the end of the accounting year, the company may have to pay a special tax called a section 455 charge.
This charge is equal to 33.75% of the outstanding loan and is paid to HMRC. It can eventually be reclaimed but only once the loan is repaid or formally written off. If the company failed to report or pay this charge in the past, HMRC can still demand it later, along with interest.
It’s also worth noting that where a loan is written off, the company is not allowed to claim a corporation tax deduction on the amount. In other words, writing off the loan could create a double tax hit: the company pays the section 455 charge and loses a potential deduction.
So, what should you do if you’ve received a letter (or even if you haven’t)?
If HMRC has contacted you about a director’s loan that was written off, do not respond without fully understanding the wider implications. You should first review how the loan was treated on your personal tax return, and whether the correct steps were taken by the company. We highly recommend consulting with a qualified tax professional in the first instance.
In many cases, directors might not even realise that a loan has been released. For example, if a debt is transferred to someone else, or quietly cleared off the books, it could still count as a release in HMRC’s eyes.
Companies should also take a step back and ask whether they have proper systems in place to track director loans, interest payments, and repayments. Do you know if any loans fall under the section 455 rules? Has interest been physically paid, or just added to the loan balance? Are there any older loans that have been written off without being reported?
If any part of this process has been handled incorrectly, it’s not just the director at risk, HMRC could choose to investigate the company too.
Speak to a tax adviser before you reply to HMRC
Whether you’re a director with a written-off loan or a business owner managing these issues on behalf of your company, it’s important to seek professional tax advice. Responding to HMRC without a full understanding of the tax implications could potentially make things worse, not better.
A coordinated approach between the director and the company is often the best way forward. With the right guidance, it’s possible to correct past mistakes, minimise penalties, and bring both personal and corporate tax affairs up to date.
Next Steps
We specialise in navigating complex tax rules, so if you need help or just want peace of mind, our team can help so get in touch.
We were approached by a client who had recently realised he had incorrectly reported his occupational pension scheme contributions on his tax return. Whilst the tapering provisions had been considered, he had failed to calculate and report the annual allowance charge (AAC) which applies when total contributions exceed the annual allowance.
Issue
Our client had filed previous year tax returns incorrectly and as there was no AAC reported, had filed these returns with an underpayment of tax.
How we solved it
We worked with our client to understand the position as it stood and how it had been reported to HMRC, compared with the correct position, which needed to be disclosed to HMRC. We assisted with a disclosure to HMRC and agreed a low penalty rate as we were able to demonstrate our client was being co-operative.
The outcome
Our client was confident in knowing that the disclosure had been handled correctly and that the lowest penalty rate possible had been agreed.
Next Steps
If you are concerned about whether the disclosure you have made is correct or not then let ETC Tax take a look.
When it comes to dealing with HMRC, the type of disclosure you choose can lead to vastly different outcomes. Navigating this process requires a clear understanding of the options available to you, as well as their implications. There are two primary types of disclosures: Prompted and Unprompted.
Prompted Disclosure
Prompted disclosure occurs when HMRC initiates contact with you, necessitating that you make a disclosure. In such cases, HMRC identifies a liability, typically involving unpaid taxes, and requests specific information from you. This form of disclosure is often a result of HMRC’s investigation or examination of your financial records.
While prompted disclosures can be unsettling, they provide an opportunity to rectify any discrepancies and address tax issues head-on. It’s crucial to provide accurate and complete information during this process. Failing to do so can lead to potential penalties or legal consequences. Therefore, prompt cooperation with HMRC is essential to resolve the matter as smoothly as possible.
Unprompted Disclosure (The Preferred Choice)
On the other hand, unprompted disclosure involves taking the initiative to approach HMRC and voluntarily declare any unpaid taxes or discrepancies in your financial affairs. This proactive approach demonstrates your commitment to complying with tax regulations and rectifying any unintentional oversights.
Opting for an unprompted disclosure significantly reduces the likelihood of facing criminal charges or severe penalties. By voluntarily coming forward and acknowledging any errors, you demonstrate transparency and a willingness to correct mistakes. HMRC generally views such disclosures more favourably, appreciating the responsible behaviour of taxpayers who take corrective actions without external prompting.
Choosing to make an unprompted disclosure not only reflects positively on your intentions but also contributes to building a cooperative relationship with HMRC. It showcases your dedication to maintaining the integrity of the tax system and can mitigate potential legal repercussions.
Expert Guidance for Disclosures
Navigating the intricate landscape of HMRC disclosures can be complex and overwhelming, especially if you’re unfamiliar with the processes involved. In such situations, seeking expert advice is a prudent step to ensure that you handle disclosures correctly and efficiently.
Our experienced team is here to offer the guidance you need. Whether you’re faced with a prompted disclosure scenario or are considering an unprompted disclosure, our professionals can provide tailored assistance. We understand the nuances of HMRC’s requirements and can help you compile the necessary information accurately.
In Conclusion
Making the right choice between prompted and unprompted disclosures to HMRC can have far-reaching consequences for your financial and legal well-being. Prompted disclosures address HMRC-initiated inquiries, while unprompted disclosures demonstrate proactive transparency. Opting for the latter can significantly diminish the likelihood of criminal charges or severe penalties.
Next Steps…
Should you find yourself in need of guidance regarding disclosures to HMRC, don’t hesitate to reach out to our knowledgeable team. We’re here to provide the expertise and support required to navigate these processes successfully. Taking the right steps now can lead to smoother interactions with HMRC and pave the way for a more compliant and secure financial future.
US musician Rockwell is often regarded as one of the greatest One Hit Wonders (“OHWs”) of all time. I mean, the titular song a bit of a tune. It has Michael and Jermaine Jackson on backing vocals for crying out loud! But how does this link into surveillance?
However, Rockwell’s status as a OHW is a controversial one. You will have to wait until the conclusion of this article for more OHW cutting edge analysis.
Eerily, his record, “I feel like somebody’s watching me…” was realised in 1984. A year synonymous with all things Big Brother.
But was our US song-writing friend on to something? Particularly when it comes to tax authorities using surveillance techniques?
This article covers aspects of surveillance but does not discuss HMRC’s usual methods of information and data collection.
Send in the drones
Putting Rockwell to one side for a minute and returning to my own musical tastes, there is perhaps no band more likely to write a song about the expansion of a tax authority’s powers than Muse.
Indeed, back in 2015, Teignmouth’s finest released a concept album about drone warfare. It was surprisingly good.
But could tax authorities around the world one day use drones to keep an eye on recalcitrant taxpayers?
It is perhaps not as far from the truth as one might think!
Back in October 2021, it was reported that the French tax authorities had launched a campaign. They planned to winkle out people who have failed to declare the existence of their swimming pools. Along with garages or other extensions that give rise to tax obligations – via a partnership with Google.
It is understood that France already used helicopters to detect undeclared swimming pools. However, this new project upped the ante somewhat.
Under the so-called Innovative Real Estate scheme, inspectors began using algorithms to automatically crosscheck aerial photos of swimming pools or house extensions with tax and property declarations.
Initially, recalcitrant pool owners would receive a written warning to regularise their affairs or face penalties.
Under the project, satellite images (freely accessible on its national database) were used as source material. These images would be scanned and compared with the land registry.
However, in addition, it was revealed that the French tax authority was also hoping to use drones to identify undeclared pools and undeclared assets!
Watch this (air) space!
RIPA not Reapers?
Again, we are back with the Devon stadium rockers.
Their song Reapers begins with a cracking tapped guitar riff. However, this section lends more to phone-tapping as we look at the Regulatory Investigatory Powers Act (“RIPA”) 2000.
RIPA provides a statutory framework for various techniques used by security and intelligence services – including surveillance.
Out of all the areas covered by RIPA, it is probably only surveillance that has any relevance to tax. It is covered in sections 28 and 29 of the Act.
HMRC is covered by this Act because it is a ‘relevant public authority’.
All sounds very Line of Duty eh?
There are broadly three levels of covert activity that might be undertaken by HMRC in relation to someone’s tax affairs:
A basic fact check: HMRC requires no authorisation for this activity
covert surveillance to observe business activity: here, authorisation from an authorised officer is required; and
directed surveillance likely to result in obtaining private information about a person: here both authorisation from an authorised officer is required along with and a so-called Directed Surveillance Authority.
HMRC sets out its understanding of these types of activity in its Manuals:
Basic fact check – not surveillance
A single walk or drive by of a business premises to make simple observations. Perhaps to establish the size of a unit, to see if the business is trading, see the external condition of a shop, or obtain details from shop signage. During this you must not engage with people or third parties.
Covert surveillance to observe business activity
Repeated walk by, drive by or visit to a business to monitor, for example, opening times
Test purchases
Test eats
Observing cash handling procedures
Counting staff and customers
Observing how customers pay.
Directed surveillance
Taking descriptions
Recording conversations
Monitoring a person’s movements and activities.
Of course, the use of surveillance raises issues under the Human Rights Act. These are still relevant following Brexit. As the Human Rights Act incorporates the provisions of the European Convention on Human Rights into UK law. This position remains unchanged.
Under Article 8 of ECHR:
every person has the right to respect for his or her private and family life, their home and their correspondence.
This may extend to his or her business activities and business premises.
However, Article 8 is a qualified right.
This means that there are circumstances where public authorities might lawfully interfere with the private and family life of an individual. Any such interference must be in accordance with the law and have a legitimate aim such as the economic well-being of the country.
That said, there must be a good reason for such interference and the level of interference must be proportionate.
As such, surveillance must therefore be proportionate.
Taxing under the Influence
As written about previously on our blog, social media influencers might find at least one unwelcome follower over the coming months.
Said follower being HMRC!
We are told that HMRC will send letters to more than 2,000 people who make income from creating content on digital platforms and 2,000 people who make money through online marketplaces, asking them to disclose their financial information to HMRC or state they have nothing to report.
An increasing number of people now make a living by promoting lifestyles, brands’ products online and selling them on e-commerce platforms and need to consider particularly:
Where they receive payment in the form of holidays, clothes, or beauty products for promoting a brand then they need to consider, whether they may need to pay tax on these goods and services.
Where they make a living from selling goods or services online then they may need to declare their earnings and complete a self-assessment tax return if they exceed the annual trading allowance of £1,000.
Nudge or ‘One to Many Letters’ are becoming a favoured tool of HMRC as they seemingly represent a low-cost way of recovering revenue.
Selfie doubt
Meanwhile, back across the Channel…
A couple of years ago, the constitutional court in France approved ‘controversial’ new rules allowing the government to trawl taxpayers’ social media postings in search of undeclared income.
At the time, human rights groups and the country’s data protection authority have expressed concern about users’ privacy being compromised, with national data watchdog the Commission Nationale de l’Informatique et des Libertes, or CNIL, saying that while it recognized the government’s aims were legitimate, personal freedom could be at risk.
But Minister of Public Action and Accounts Gerald Darmanin welcomed the news on Twitter, saying: “The constitutional court has just ruled that this experiment conforms to the constitution … one more tool to fight fraud!”
When the changes were first proposed, CNIL said that such a far-reaching data management operation could “significantly change individuals’ behavior online, where they might not feel able to express themselves freely on the platforms in question”.
However, there were important limits to these powers.
Firstly, France’s tax collectors would only be able to use content that was public – in other words, they could not override any password protected materials
Secondly, Regulators will be required to closely monitor how any information would be used.
As a helpful warning to the more careless French tax miscreant Darmanin asserted that:
“If you say you’re not a fiscal resident in France and you keep posting pictures on Instagram from France, there might be an issue..”
Indeed.
But it couldn’t happen here in the UK could it?
Well, it might be news to you, but the UK tax authorities already do this.
HMRC has publicly stated in updates to its guidance that it will “observe, monitor, record and retain internet data” which is available to everyone.
This will include information on news sites, company websites, data published at Companies House and other agencies such as the Land Registry. For example, it is clear that land registry information formed the basis of a recent HMRC campaign regarding those taxpayers it suspected had sold an investment property.
In terms of social media specifically, HMRC’s Manuals state that:
Social media is the name given to websites and applications that enable users to create and share content or to participate on social networking sites, for example Facebook, Twitter and LinkedIn.
Many businesses set up social media accounts and you can access those accounts to obtain information about the business activities.
You can also use social media to gather information about assets and lifestyles of individuals when checking the tax position of an individual…
It is clear that this only applies to ‘open source’ (ie where privacy settings are not properly in place) material on Social Media:
All analysts, investigators, intelligence officers and compliance caseworkers using civil powers are permitted to carry out research categorised under tier 1 overt open source research, in accordance with this guidance..
As such, it seems that HMRC’s powers are remarkably similar to those newly acquired by their compatriots across Le Channel.
The lesson is, if you don’t want the taxman snooping through your selfies then switch on the privacy settings!
Conclusion on Surveillance
HMRC drone squadrons might be a little way off for now.
However, we should not be surprised to see authorities around the world embracing new technology to help collect unpaid taxed. Bearing in mind the raw data that authorities now have from global improvements in information sharing, for example, AI might prove a useful tool in using this source material.
That said, some might point out the irony in engaging ‘big tech’ to help swell the coffers bearing in some of their more ‘controversial’ approach to tax planning!
Nudge letters perhaps remain a more ‘lo-fi’ and cost-effective tool to ‘encourage’ better compliance with tax rules.
So, Rockwell fans, what was that controversy about his status as a OHW? Well, Rockwell had another US Top 40 hit reaching the dizzy heights of #35.
It was called Obscene Phone Caller.
Perhaps there’s another article there around HMRC’s service standards?
