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      The Government’s recent consultation on modernising the taxation of distributions and repayments of capital from companies, which is discussed in greater detail in a separate article in this edition, includes proposals to extend the loans to participators tax rules to loans made by non-UK resident closely controlled companies.

      While these are intended to align the treatment of UK and non-UK resident companies, if taken forward, they could create particular issues that non-UK resident companies will need to consider in the context of Management Incentive Plans (MIPs).

      It is not yet known whether any of these proposals will be taken forward. However, employers can take steps now to model what impact they might have on their current MIPs. As part of that exercise, employers should also consider whether their tax compliance position in relation to current loans to employees for both employment tax and, where relevant, close company participator loan purposes, is correct.

      Employee loans and MIPs

      In many private companies, MIPs are designed so that senior management invest in shares alongside founders and investors.

      It is not uncommon for companies to provide loans to fund the acquisition of the shares (either by the employer company or another company in the group). This allows management to participate as shareholders where they may not have access to resources to invest, and therefore encourages meaningful alignment between management and shareholders. In some circumstances, the loans may also be used to fund the ‘dry’ tax charge that may arise for the employee where their shares are gifted.

      These loan arrangements are therefore driven by commercial considerations to align and incentivise employees. In practice, such loans are frequently intended to remain outstanding until a liquidity event, such as a sale of the company or an IPO. Unlike listed company shareholders, private company shareholders often have no immediate market for their shares and may not be able to realise value for a number of years. As many growth businesses are now taking longer to reach an exit than was historically the case, it is increasingly common for these loan arrangements to remain in place for extended periods.

      Edward Groves

      Partner, Reward, People Services Tax

      KPMG in the UK

      The current loans to participators rules

      One of the difficulties from a tax perspective is that loans to employee/management shareholders can fall within the loans to participators rules. This regime prevents owner-managers in close companies accessing company funds through loans, rather than taxable distributions, without any tax on the value of the funds obtained.

      Broadly, a close company is a UK resident company that is controlled by five or fewer participators or by any number of participators who are directors. A participator is a person who has a share or interest in the capital or income of the company and includes a shareholder or an individual with a right to acquire shares.

      Where a close company makes a loan to a participator that remains outstanding more than nine months following the end of the accounting period in which it was made then, subject to certain exclusions, a corporation tax charge arises for the company on that loan. That amount is reclaimable from HMRC when the loan is repaid, or it is released or written off (and the participator is taxed as though they had received a distribution to the extent that the loan is released or written-off).

      The proposals under consultation

      Currently, the rules outlined above apply to UK-resident close companies only, but the consultation puts forward proposals to extend the rules (and replicate them, in so far as is feasible) to loans made to participators by non-UK companies.

      However, the Government recognises that because non-UK resident companies are not typically within the UK corporation tax regime, it is not possible to achieve full alignment of the rules. The consultation therefore considers alternative approaches, which may include imposing the charge directly on the UK-resident recipient of the loan (i.e. the relevant employee/manager) instead of the non-UK resident company.

      Were such rules to be introduced, a UK employee acquiring shares using a loan from a non-UK resident close company could therefore face personal tax consequences that would not arise where an otherwise identical loan is provided by a UK-resident close company.

      In addition, there are already in place a number of separate tax rules which can apply to the employee/manager being made an employment-related loan. These rules can apply, variously, when the loan is made, while the loan remains outstanding and if the loan is released/written-off. It is not yet clear how any new charge imposed on the employee/manager would interact with these existing tax rules for employment-related loans.

      The consultation sets out a number of different options, including a suggestion that the charge would not apply to employees who do not have a material interest in the company, or would not arise unless the loan were still outstanding after a period of time, for example three years, or, that no charge would be due on the making of the loan but it would be deemed to be written off/released after a set period of time if it has not been repaid, such as five years.

      However, these suggestions do not sit comfortably with how MIPs operate in practice - as noted above, loans to fund management investment are frequently expected to remain outstanding until an exit event, which may not occur for a significant number of years.

      Additional reporting requirements?

      The Government has also recently consulted in relation to modernising the framework for reporting transactions, including in relation to loans, from close companies to participators. The consultation proposed additional reporting for the relevant close company.

      It remains to be seen how such enhanced reporting, if introduced, might apply in the context of the proposals outlined above for non-UK resident companies.

      Introduction of an employee share scheme exemption?

      Given that employee share ownership remains an important component of the UK’s growth agenda, in our view there is a strong argument for a targeted exemption from the relevant rules (regardless of whether the relevant company is UK or non-UK resident) where the shares are acquired pursuant to a bona fide employee share scheme.

      We put this to the Government as part of our consultation response. However, responses to the consultation are currently under consideration by the Government, and it remains to be seen what approach it will take.

      What should companies do now?

      We do not yet know whether any of these proposals to extend some form of the UK close company participator loan regime to non-UK resident companies will be taken forward. Potentially affected employers should therefore monitor HMRC’s response to the consultation and any legislative developments closely, particularly where MIPs are an important part of the company’s strategy.

      Some indication of the likely timescale for a full response to the representations made might be given in October’s Budget. In the meantime, employers can model what impact the consultation proposals might have on their existing MIP structures.

      They should also confirm whether, if asked to do so by HMRC, they could demonstrate compliance with the current close company loans to participators (where relevant) and employment-related loan tax regimes.

      Key points to consider include:

      • What process does the employer have to identify existing loan-funded share arrangements, particularly where funding has been provided by non-UK group companies?; and
      • How could the proposals to extend some form of the current close company loan charge regime to non-UK resident companies affect the group MIP as it currently operates – and what alternative funding mechanisms might be preferable?

      How KPMG can help

      We advise UK and non-UK companies on all aspects of the design and operation of MIPs, including in relation to the design and tax implications of funding arrangements. Please contact the authors or your usual KPMG contact to discuss what these issues could mean for your business.

      For further information please contact:

      Our tax insights

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