Close Company Rules

A close company is a UK-resident company that is under the control of five or fewer participators (broadly, shareholders) or of any number of participators who are also directors. The majority of small family-owned limited companies are close companies. Because close companies can be used to extract value from the business in ways that avoid tax, HMRC applies additional rules — known as the close company rules — which are designed to prevent tax avoidance by treating certain transactions as distributions or loans. Understanding whether your company is close, and what obligations arise, is essential for compliance.

Definition of a Close Company

A company is close if it is under the control of five or fewer participators (or any number of participators who are directors). Control is defined broadly — it includes the ability to exercise voting power, control the company's board, or control more than half of the company's share capital or distributable income. Participators include shareholders, loan creditors, and anyone entitled to participate in the company's distributions. A company is not close if it is limited by guarantee, if it is a registered industrial and provident society, or if at least 35% of its shares are held by the public (a "publicly controlled" company). Associated companies of a close company are themselves treated as close in certain circumstances. For a typical small business with a few shareholders, the close company status is virtually automatic.

Loans to Participators — Section 455 Charge

The most important close company rule is the s455 charge on loans to participators. If a close company makes a loan or advances credit to a participator (or an associate of a participator) — such as a director's loan account overdrawn at the year-end — the company must pay tax at 33.75% of the loan amount. This is not a final tax — it is repayable to the company when the loan is repaid, written off, or released. The s455 charge is due nine months and one day after the end of the accounting period in which the loan was made and is reported on the CT600. If the loan is not repaid, the tax is not refunded (although certain exceptions apply for small amounts, limited to £15,000 per employee, and for loans made in the ordinary course of the company's business). Many small companies are caught out by this rule — the director's personal use of the company bank account or a simple overdrawn loan account can trigger a significant tax charge.

Benefits and Expenses for Participators

Close companies that provide benefits or expenses to participators (or their associates) are subject to special reporting rules. If a benefit is provided to a participator who is also an employee, it is reported on form P11D and taxed through PAYE. If the participator is not an employee, the benefit is treated as a distribution — the company receives no tax deduction, and the participator is taxed on the benefit as if it were a dividend. This is a common issue in family companies where the director's spouse or children (who may not be employees) receive benefits such as a company car, private medical insurance, or free accommodation. The distribution treatment means the benefit is added to the participator's income and taxed at dividend rates.

Settlement Legislation

HMRC can apply the settlements legislation (ITTOIA 2005, Part 5, Chapter 5) to reallocate income from one person to another where there has been an arrangement involving a close company. This is often used where a director settles shares on their spouse or children — if the dividend income from those shares is not the result of the spouse or child's own efforts, HMRC may argue that the dividends are still the director's income. The leading case is Arctic Systems Ltd v HMRC (Jones v Garnett), where the husband settled shares in a company on his wife, and HMRC tried to reallocate dividends back to the husband. The House of Lords held that if the spouse provides services that generate the profits, the settlement legislation does not apply. However, if the spouse is purely passive, the settlement rules can reallocate the income. Careful planning is required when structuring shareholdings in family companies.

TCGA Section 13 — Attributable Gains

Under TCGA 1992, Section 13, chargeable gains made by a close company can be attributed to the participators in proportion to their shareholdings. This prevents the company from making a gain at a low Corporation Tax rate while the participators avoid Capital Gains Tax. If the gain would have been chargeable on the participator if they had made it directly, HMRC can apportion a share of the gain to each participator and tax it as if it were the participator's own gain. The company can reclaim the Corporation Tax it paid on the gain to avoid double taxation. The rule applies only to gains on assets that are not trading assets — disposals of investment property, shares, and other capital assets are typically caught.

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