Many businesses build up substantial cash reserves over time. Whilst directors often extract profits through salaries, dividends or pension contributions, another option is to establish a second company and transfer funds using an intercompany loan.
At first glance, this can seem like a simple and tax-efficient way to deploy surplus cash. The reality, however, is that the transaction may bring the Associated Companies rules into play. These rules can affect corporation tax rates, profit thresholds and payment deadlines, so understanding the potential implications is essential before moving funds between connected businesses.
Why Use an Intercompany Loan?
An intercompany loan allows one company to lend money to another company within the same ownership structure.
Business owners commonly use such arrangements to fund:
- Property acquisitions
- New business ventures
- Capital investment projects
- Expansion opportunities
- Working capital requirements
Rather than withdrawing funds personally and incurring potential tax liabilities, surplus cash remains within a corporate environment and can be used to support commercial growth.
Before proceeding, it is important to understand the tax rules that apply.
Understanding the Loan Relationship Rules
Most intercompany loans fall within the loan relationship regime.
A company will usually be party to a loan relationship where:
- It is a creditor or debtor in respect of a money debt.
- The debt arises from the lending of money.
As a result, many loans between connected companies automatically fall within these provisions.
What Happens When Interest Is Charged?
Where interest is payable on an intercompany loan, both companies need to consider the tax consequences.
The lending company will normally treat the interest received as a taxable loan relationship credit. The borrowing company may be entitled to relief for the interest paid as a loan relationship debit, subject to the normal corporation tax restrictions.
The overall tax impact should therefore be considered across both companies rather than looking at each business separately.
Can a Loan Be Interest Free?
Yes.
Many intercompany loans are structured without interest. However, an interest-free loan can still fall within the loan relationship rules.
Business owners should therefore avoid assuming that removing interest removes the tax implications. Proper documentation remains important regardless of whether interest is charged.
What Happens If the Loan Is Written Off?
Problems can arise when the borrowing company is unable to repay the loan.
In many cases, HMRC may deny relief where a connected company writes off an intercompany debt. A write-off that appears commercially sensible may therefore fail to provide the tax relief that directors expect.
This is one reason why intercompany lending arrangements should be carefully planned from the outset.
What Are Associated Companies?
The term Associated Companies has a specific meaning for corporation tax purposes.
Companies are associated where:
- One company controls another; or
- The same person, or group of people, controls both companies.
Many owner-managed businesses assume separate companies automatically stand alone for tax purposes. Unfortunately, that assumption is often incorrect.
How Is Control Determined?
Control generally includes the ability to acquire more than 50% of:
- Ordinary share capital
- Voting rights
- Distributable profits
- Assets available on a winding up
Where these conditions are met, companies may be regarded as associated even if they operate in different sectors or undertake very different activities.
Do Family Relationships Matter?
Yes.
When determining control, HMRC may attribute rights held by associates.
Associates can include:
- Spouses and civil partners
- Parents and grandparents
- Children and grandchildren
- Brothers and sisters
- Business partners
- Certain trustees and settlors
Consequently, family ownership structures can create associated company relationships that may not be immediately obvious.
Commercial Interdependence and Associated Companies
Where family ownership and associates are involved, HMRC will often consider whether substantial commercial interdependence exists between businesses.
Three factors are particularly important.
Financial Interdependence
Financial interdependence may exist where companies support one another financially.
Examples of Financial Interdependence
- Intercompany loans
- Cross-company guarantees
- Shared borrowing facilities
- Financial support arrangements
Economic Interdependence
Economic interdependence focuses on the commercial relationship between companies.
Examples of Economic Interdependence
- Shared customer bases
- Reliance on another company for income
- Complementary trading activities
- Common supply chains
Organisational Interdependence
HMRC may also review how businesses operate on a day-to-day basis.
Examples of Organisational Interdependence
- Shared premises
- Shared equipment
- Shared employees
- Common management structures
- Centralised administration
Direct share ownership is always considered, regardless of whether commercial interdependence exists.
Tax Implications of Associated Companies
The Associated Companies rules can have a significant impact on corporation tax liabilities.
Companies with profits falling within the small profits threshold currently pay corporation tax at 19%, whilst profits above the upper threshold may be taxed at 25%, with marginal relief applying between the two limits.
The key point is that these thresholds are divided equally between associated companies.
A Simple Example
Suppose two companies are associated.
Instead of each benefiting from the normal £250,000 upper threshold, the threshold is effectively reduced to £125,000 per company.
As a result, both businesses can enter the higher corporation tax band sooner than expected.
Directors often focus on the commercial benefits of creating additional companies without recognising the corporation tax consequences.
Associated Companies and Corporation Tax Payment Deadlines
Associated companies can also affect when corporation tax is payable.
A company generally enters the quarterly instalment payment regime when it becomes a large company. The relevant profit threshold is divided by the number of associated companies at the end of the previous accounting period.
Consequently, businesses can find themselves making corporation tax payments much earlier than anticipated.
Instead of paying corporation tax nine months and one day after the end of the accounting period, instalment payments may become due during the accounting year itself.
For growing businesses, this can create unexpected cash flow pressure.
Dormant and Passive Companies
Not every company will necessarily count for associated company purposes.
Dormant companies are generally ignored. Certain passive holding companies may also be excluded where their activities are restricted to holding shares and receiving dividends.
However, every situation should be reviewed carefully, as the rules can be complex.
Practical Point
Intercompany loans can be an effective way to utilise surplus cash within a business structure. However, the Associated Companies rules should never be overlooked.
A second company may create valuable commercial opportunities, but it can also reduce corporation tax thresholds, accelerate payment deadlines and affect the availability of tax relief on loan write-offs.
Before transferring funds, ensure all intercompany loans are properly documented and review ownership, control and commercial relationships regularly. Understanding the impact of Associated Companies today can help prevent costly tax surprises tomorrow.
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