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Tax Essentials: Direct Taxes 2005-06 by Mark McLaughlin CTA (Fellow) ATT TEP and Sarah Laing CTA

Mark McLaughlin CTA (Fellow) ATT TEP and Sarah Laing CTA, outline the meaning of ‘Close Company’ and some potential tax implications.

What is a ‘close’ company?

A company is ‘close’ if it is:

• under the ‘control’ of 5 or fewer ‘participators’ (including ‘associates’);
• under the control of any number of participators who are ‘directors’ (including associates).

A company is also close braodly where 5 or fewer participators, or participators who are directors, together possess or are entitled to acquire rights to receive the greater part of the assets (with or without taking the rights of any loan creditors into account), based upon a notional winding up of the company.

The main exceptions

A company will not be a close company if it is:

• not resident in the UK;

• a UK resident company controlled by a non-resident company (unless the non-resident company would itself be close if resident in the UK);

• a company controlled by a non-close company or companies, where it cannot be treated as a close company except by including a non-close company as one of its 5 or fewer participators;

• a quoted company:

(a) where 35% or more of the company’s voting power is held by the ‘public’ (excluding shares entitled to a fixed rate of dividend); and

(b) within the preceding 12 months those voting shares have been the subject of dealings on a recognised stock exchange unless the total voting power of the company’s ‘principal members’ exceeds 85% (including shares entitled to a fixed rate of dividend).

Close companies — definitions

Control is the ability to exercise, or entitlement to acquire, control over the company’s affairs, including the ownership of, or entitlement to acquire:

• over 50% of the company’s share capital; or

• over 50% of the company’s voting rights; or

• the right to receive over 50% of the company’s distributable income; or

• the right to receive over 50% of the company’s distributable assets.

A director includes any person:

• who acts in that capacity (whatever title is given); or

• who gives directions upon which directors are accustomed to acting; or

• who is concerned in the management of the company’s business and controls, or is able to control (with or without associates) 20% or more of the company’s ordinary share capital.

A participator includes a person with a financial interest in the company, such as a shareholder or loan creditor, but excludes normal trade creditors of the company.

An associate of a participator is defined as:

• Any ‘relative’ — spouses, parents or remoter forebear, children or remoter issue, brothers or sisters (but not aunts, uncles, nephews and nieces). Separated spouses and half-brothers or sisters are associated, but divorced spouses and step-brothers or sisters are not;

• any business partner;

• the trustee(s) of any settlement in which the participator (or any living or dead ‘relatives’) is or was the settlor; and

• the trustee(s) of a settlement or personal representatives of an estate holding company shares in which the participator has an interest (where the participator is a company, any other company interested in those shares is also an associate).

The public excludes

• directors and their associates;

• any company controlled by them;

• any associated company;

• any fund for the benefit of past or present employees, directors or dependants of the company or associated companies; and

• the principal members.

A principal member is a person holding more than 5% of the company’s voting power or where there are more than 5 such persons, one of the 5 possessing the greatest percentages. Where two or more persons hold equal percentages, so that the greatest percentages are held by more than 5 persons, a principal member is any one of that number.

Tax implications for close companies

The company must self-assess tax liabilities in respect of loans to participators or associates, which can result in the requirement to make tax payments to Revenue & Customs equal to 25% of the outstanding loan or advance made during the accounting period. The tax need not be paid if the loan has been repaid, released or written off within 9 months and 1 day following the end of the accounting period. Where the loan or advance is repaid, released or written off more than 9 months after the end of an accounting period, the tax paid can be repaid 9 months after the end of the accounting period in which the repayment, release etc. takes place.

Where a close company incurs an expense in the provision of benefits or services to a participator who is not a director or employee earning £8,500 or more, that expense (calculated under the taxable benefit rules for employments) is normally treated as a distribution rather than an allowable expense of the company.

The small companies and starting rates of corporation tax can be utilised by a close company, but not by ‘close investment holding companies’ which pay corporation tax at the full rate, regardless of profit levels.

June 2005

Mark McLaughlin CTA (Fellow) ATT TEP is a tax consultant and Editor of TaxationWeb. Sarah Laing CTA of CPE Consulting is an author.

The above article is adapted from ‘Tax Essentials – Direct Taxes 2005-06’ published by Tottel Publishing. To order Tax Essentials – Direct Taxes 2005-06, < click here