HMRC has launched a consultation on whether to reform the rules governing the taxation of close company loans to their participators, usually the owners and shareholders, and is seeking feedback on the options.

Close companies are typically small companies owned and managed by five or fewer people. According to HMRC, nearly 70% of directors indicated in their 2011/12 self-assessment tax returns that they were directors of close companies and close companies account for the vast majority of incorporated businesses.

It is common practice for directors and shareholders to take loans from their close companies. If the loan is repaid to the company within nine months of the end of the accounting period there are no tax consequences. However, if the loan is still outstanding more than nine months after the end of the accounting period in which it was made, the company must pay a tax charge of 25%, s455, Corporation Tax Act 2010. The 25% tax charge will be repaid if the loan is repaid.

In Budget 2013 the government announced it wanted to look at the use of such loans, from the point of view of a number of factors including possible tax avoidance, simplicity, fairness and the administrative burden.

In its consultation paper HMRC points out, for example, that under the current regime, the amount of section 455 tax due in no way reflects the length of time the participator has the use of the company's money. The only benefits to the close company of the participator paying it back earlier are that it can reclaim the tax sooner and pay less interest. HMRC says arguably a fairer system would reflect both the amount and how long the participator has use of the company's money.

According to HMRC, the administrative burdens on customers of claiming repayments of section 455 tax currently amount to approximately £1m per year. The department says it must also process these claims manually, which is costly and time consuming.

There are four broad options outlined in the consultation paper. The first two are to maintain the current regime, or to increase the tax rate but retain the structure and operation of the regime.

A third alternative is to replace the current repayable charging system with a lower rated but permanent charge which arises annually on amounts outstanding at the end of each accounting period until the extraction is repaid to the close company. The fourth option is to replace the current repayable charging system with a lower rated but permanent charge which arises annually on average amounts outstanding during the accounting period.

ICAEW has pointed out that its members are likely to have many clients who operate through close companies and may also run their own practices through close companies, so the reforms are likely to have a major impact on advice given to clients.

Any changes to the rules on loans would be introduced in April 2014, but HMRC says any loans, advances or arrangements already in place under the previous system would continue.

Responses to the consultation should be sent by 2 October 2013 by email to Ellen Milner at [email protected]