Bankrolling Your Brother's Startup: 33.75% Tax Trap

Introduction: Powering Up a Dream

In our blog this week I wanted to take a look at how contractors can make use of excess funds held in their business bank account. In particular I wanted to investigate how those funds can be distributed to a family member to help them pursue their own business idea. Is this case we’re looking at two brothers, but the same rules apply when looking at similar transactions with (a) husband, wife or civil partner, (b) parents, grandparents and other direct forebears (c) children, grandchildren and other direct descendants, and (d) brothers and sisters.

So firstly lets paint a picture – Tim, a Wellington-born IT developer is a full-stack developer working in Manchester. Tim has been a freelancer for a few years now, whose company Prince Tui Tech Ltd is sitting on a healthy pile of retained profits from his £140k-a-year contracting gigs.

His little brother Josh has just unveiled his plan for “Kornish Heat Ltd,” a cutting-edge geothermal start-up. He’s found the perfect spot in Cornwall, ideal for a pilot micro-geothermal power plant. His engineering skills learnt at Taupō’s Wairakei plant is shining through – he’s planning to use low-temperature brine and Organic Rankine Cycle turbines, to generate a respectable 400kW for the local grid.

£60,000 is what Josh needs for the seed funding – surveys, drilling permissions, a down-payment on the turbines. Investing in cutting-edge renewable tech? Tick. Backing his brother’s brilliant idea and a bit of “number 8 wire fencing mentality from back home” on UK soil? Another tick.

That is, until a little ping from his accountant lands in his inbox. “Fantastic project, Tim, sounds like a winner! Just a quick one… have you factored in the 33.75% s455 whack if you just pull the cash straight from Tui Tech to lend to him?”

Suddenly, the steam clears and some tax planning ideas start to form.

If you’re a Kiwi or Aussie contractor here in the UK, successfully running your own limited company, the thought of using your hard-earned business funds to support a family member’s dream is probably a familiar and appealing one. And, as Tim is about to discover, with proper tax planning you can navigate the UK tax landscape without getting scorched by HMRC.

The £60,000 Question: How Should Prince Tui Tech Fund Kornish Heat?

So, now we need to turn to that all-too-familiar contractor conundrum: how to get funds out of his company, Prince Tui Tech Ltd, in a way that’s both supportive of Josh’s venture and sensible from a tax perspective. That 33.75% tax figure from his accountant has certainly focused his mind on the need for a proper plan.

There are two main paths forward for channelling that £60,000 from Prince Tui Tech Ltd to help get Kornish Heat Ltd off the ground:

1. Option 1: The “Director’s Loan” Detour. This is probably the most obvious route that springs to mind for many contractors. Prince Tui Tech Ltd would lend the £60,000 directly to Tim. He’d then, in his personal capacity, lend that same sum to his brother, Josh. Simple on the surface, but as we’ll see, this path comes with potential tax potholes.
2. Option 2: The “Company-to-Company” Direct Hit. Alternatively, Prince Tui Tech Ltd could lend the £60,000 directly to Josh’s new company, Kornish Heat Ltd. This keeps Tim out of it personally, making it a straightforward business-to-business loan. Sounds cleaner, doesn’t it? But it has its own set of rules and risks to consider.

Both options have very different tax consequences, not just for Tim and Prince Tui Tech Ltd, but potentially for Josh and Kornish Heat Ltd too.

So let’s unpack the tax implications of each route – because making the wrong choice here, or not structuring things correctly, could indeed cost Prince Tui Tech Ltd much more than it needs to.

Option 1: The Director’s Loan Route – Riding the S455 Tax Trap

The short answer is, its best to avoid this option. Not good enough for you? OK then, lets get into the detail.

So, Tim’s first thought might be to simply get Prince Tui Tech Ltd to lend him the £60,000 as a directors loan, and then he passes it on to Josh. On the face of it, it seems straightforward. However, this is where that “33.75% tax” his accountant mentioned comes into play, due to a piece of tax law called Section 455.

What is this Section 455 Tax?

For contractors running their own limited company – which HMRC usually terms a “close company” – Section 455 of the Corporation Tax Act 2010 is a critical rule to understand.

1. The basics: It’s a tax charge levied on your company if it makes a loan to you (as a director and shareholder, known as a “participator”) and that loan isn’t fully repaid relatively quickly.
2. The sting: If Tim still owes Prince Tui Tech Ltd any part of that £60,000 more than nine months and one day after the company’s financial year-end, HMRC steps in. They’ll demand Prince Tui Tech Ltd pay tax at 33.75% on the outstanding loan amount.
3. For Tim’s £60k: If the full amount is outstanding past this deadline, that’s a hefty £20,250 tax bill for Prince Tui Tech Ltd to pay over to HMRC (£60,000 x 33.75%). Ouch!
4. Cashflow pain: This £20,250 isn’t just a paper exercise; it’s actual cash that Prince Tui Tech Ltd has to pay. That’s money tied up with HMRC that could otherwise be used in the business or, eventually, distributed more efficiently.
5. Is it temporary? Yes, thankfully. This S455 tax isn’t designed to be a permanent penalty. Prince Tui Tech Ltd can reclaim the tax it paid once Tim repays the loan to the company. However, with Josh’s project looking at a five-year timeline for loan repayment from Kornish Heat Ltd, Tim might not be in a position to repay Prince Tui Tech Ltd for several years. Even when he does, if the S455 tax has already been paid, the reclaim from HMRC can only be made nine months after the end of the accounting period in which Tim makes his repayment. So, that £20,250 could be out of Prince Tui Tech’s bank account for quite some time.

Thinking of a Quick Repay & Re-Draw? Beware “Bed & Breakfasting”!

“Ah,” some might think, “can’t Tim just repay the loan just before the nine-month deadline to avoid the S455 tax, and then Prince Tui Tech Ltd lends it back to him a few days later?”

Unfortunately, HMRC is wise to these sorts of manoeuvres, often called “bed and breakfasting.” They have specific anti-avoidance rules to stop this:

1. The “30-Day Rule” (found in CTA 2010, s464ZA(1)): If Tim repays £5,000 or more of his loan, but then within 30 days Prince Tui Tech Ltd makes new loans or advances to him also totalling £5,000 or more, HMRC will likely match the repayment against the new loan, not the original one. This means the S455 tax on the original loan will still be due.
2. The “Arrangements Rule” (CTA 2010, s464ZA(3)): This one applies if Tim owes £15,000 or more before making a repayment, AND at the time he makes that repayment, there are already “arrangements” in place for Prince Tui Tech Ltd to make new loans or advances of £5,000 or more to him. Again, the repayment is effectively ignored for S455 relief on the first loan. “Arrangements” can be interpreted very broadly by HMRC.
3. The bottom line: Repayments must be genuine and lasting – what HMRC calls “enduring repayments” – to successfully avoid or reclaim S455 tax. Given Josh needs the funds for his five-year plan, Tim can’t realistically make an enduring repayment to Prince Tui Tech Ltd within the S455 window without genuinely finding the cash from elsewhere.

The Hits Keep Coming: Benefit-in-Kind (BiK) Tax

But wait, there’s more. If Prince Tui Tech Ltd lends Tim more than £10,000 in total at any point in the tax year, and he’s not paying a commercial rate of interest on it (or pays no interest at all), HMRC sees this as a taxable perk – a Benefit-in-Kind (BiK).

1. HMRC’s Official Rate of Interest (ORI): To avoid this BiK, any interest Tim pays must be at least equal to HMRC’s Official Rate of Interest. It’s important to note that this rate isn’t static. For the 2025/26 tax year (which we are now in), the ORI is 3.75%. This was a notable jump from the 2.25% in previous years.
2. Tim’s personal tax: The value of this benefit (the difference between interest at ORI and what Tim actually pays) is added to Tim’s other income for the year, and he’ll pay income tax on it at his marginal rate (potentially 40% or higher).
3. Prince Tui Tech’s extra bill: On top of Tim’s personal tax, Prince Tui Tech Ltd has to pay Class 1A National Insurance Contributions (NICs) on the cash equivalent of Tim’s benefit. For the 2025/26 tax year, this Class 1A NIC rate is 15%, another increase from the previous 13.8%.

Let’s illustrate with Tim’s £60,000 loan, assuming he pays no interest to Prince Tui Tech Ltd during the 2025/26 tax year:

1. The taxable benefit for Tim would be £60,000 x 3.75% (ORI) = £2,250.
2. If Tim’s a higher-rate taxpayer (40%), he’ll personally owe an extra £900 in income tax (£2,250 x 40%).
3. Prince Tui Tech Ltd will owe Class 1A NICs of £337.50 (£2,250 x 15%). These BiK and Class 1A NIC charges will apply every year the loan remains outstanding over £10,000 and isn’t charged appropriate interest – all while Prince Tui Tech might also be out of pocket from paying the S455 tax.

And if Prince Tui Tech Writes Off Tim’s Loan?

What if, down the line, Tim can’t repay Prince Tui Tech Ltd and the company decides to write off the £60,000 loan? Well, it’s not a simple “let’s forget about it.” Generally, the amount written off is treated as a distribution to Tim – similar to a dividend – and he’ll have to pay income tax on it at his dividend tax rates. Prince Tui Tech Ltd can reclaim any S455 tax it originally paid on the loan. However, the company usually won’t get a Corporation Tax deduction for the amount of the loan written off when it’s treated this way. So, the “temporary” S455 tax on the company effectively gets replaced by a “permanent” income tax hit for Tim.

The Final Leg: Tim’s Personal Loan to Josh

Just to briefly cover all bases with this option: once Tim has the funds from Prince Tui Tech Ltd, the onward loan from him to Josh is a personal matter between the two brothers. If Tim charges Josh interest on this personal loan, that interest income would be taxable savings income for Tim, and he’d need to declare it on his Self Assessment tax return. The detailed tax consequences of this personal loan leg are a bit beyond the main focus here, which is the company tax implications for getting the funds to Tim in the first place.

As you can see, what seems like a simple director’s loan can quickly become a complicated and costly affair if you’re not careful.

Option 2: The Company-to-Company Loan – A Simpler Path, Or More Hidden Traps?

Given the headaches associated with director’s loans, Tim’s next thought might be for Prince Tui Tech Ltd to lend the £60,000 directly to Josh’s new company, Kornish Heat Ltd. This keeps Tim out of the transaction personally, and it becomes a loan from one business to another. It certainly feels like it should be cleaner, and it is. But this route has its own set of tax rules and potential pitfalls that it really helps to be aware of.

The Setup: Prince Tui Tech Ltd Lends Directly to Kornish Heat Ltd

When one UK company lends money to another, the arrangement is governed by what HMRC calls the “loan relationship” rules.

1. Interest Treatment: If Prince Tui Tech Ltd charges Kornish Heat Ltd interest on the loan – let’s say at a commercial rate like 6% per annum as Tim was initially considering – this interest received by Prince Tui Tech Ltd is taxable income and will form part of its profits for Corporation Tax purposes. For Josh’s company, Kornish Heat Ltd, the interest it pays could be a deductible expense against its own profits, provided the loan is used for its business purposes and the interest meets certain conditions.

This sounds fairly straightforward so far, and it is.

The Big Risk: What if Kornish Heat Can’t Repay? (The “Connected Companies” Issue)

This is a major one for Tim to consider. What happens if, despite Josh’s best efforts, Kornish Heat Ltd struggles and can’t repay the £60,000 loan? Can Prince Tui Tech Ltd just write it off as a bad debt and get tax relief?

1. Are Prince Tui Tech Ltd and Kornish Heat Ltd “connected”? For tax purposes, companies are often considered “connected” if one controls the other, or if both are controlled by the same person or persons. “Persons” can include their “associates” – and yes, a brother usually counts as an associate. Given Tim controls Prince Tui Tech Ltd and his brother Josh will likely control Kornish Heat Ltd, HMRC would almost certainly see these two companies as “connected.”
2. Consequences: If the companies are connected, and the loan goes bad, Prince Tui Tech Ltd will generally get NO Corporation Tax relief for the impairment loss or for the £60,000 if it’s written off. That means Tim’s company bears the full brunt of the loss without any tax deduction to soften the blow. A tax deduction would help soften the blow, but really, the risk here is that Prince Tui Tech Ltd takes a £60k hit if the loan goes bad – which I think would make sense to most people.

Playing it Straight: The Arm’s Length Rule & Why It Matters

Even if the loan is between two UK companies owned by brothers, HMRC expects the transaction to be conducted on an “arm’s length” basis. This means the terms of the loan (like the interest rate, repayment schedule, and any security) should be similar to what would be agreed between two unrelated companies acting independently and in their own commercial interests.

What does this mean? Don’t for example look for ways of shifting income by setting an artificially high interest rate to shift profits to Prince Tui Tech Ltd from Kornish Heat Ltd.

Could S455 Sneak In Anyway? The Targeted Anti-Avoidance Rule (s464A TAAR)

Here’s where things can get interesting. Tim might think that by structuring this as a company-to-company loan, he’s completely sidestepped that nasty Section 455 tax we talked about in Option 1. But the answer is No.

Imagine Prince Tui Tech Ltd lends £60,000 to Kornish Heat Ltd completely interest-free, with very loose repayment terms, no security, and little commercial assessment of Kornish Heat’s viability. If it looks less like a genuine commercial loan from Prince Tui Tech Ltd and more like a way for Tim to use his company’s money to directly benefit his brother Josh personally (perhaps by Josh then taking funds out of Kornish Heat Ltd easily, rather than Kornish Heat using the loan entirely for its own business development), HMRC could argue the s464A TAAR applies. The less commercial the loan looks, the higher the risk.

Bottom line. Don’t loan funds from your business to another business, just as a tricky tax free way of getting personal use of those funds. The HMRC have been onto this for years, and s464A TAAR specifically addresses this.

So, while an inter-company loan can avoid the automatic S455 charge and the Benefit-in-Kind issues seen in Option 1, it must be structured on a well-documented proper commercial footing.

So, What’s the Best Route for Tim (and You)?

Let’s try to boil it down. Which path offers the least pain and most potential for successfully backing Josh’s Kornish Heat project?

1. Option 1 (The Director’s Loan Detour): This route, where Prince Tui Tech Ltd lends to Tim who then lends to Josh, almost certainly means an upfront S455 tax payment of 33.75% of that £60,000 for Prince Tui Tech Ltd. That’s a big hit to the company’s cashflow from day one. On top of that, there are the ongoing Benefit-in-Kind tax implications for Tim personally, and the Class 1A National Insurance contributions for Prince Tui Tech Ltd. With the Official Rate of Interest now at 3.75% and Class 1A NICs at 15% (as of April 2025), these annual costs are more significant than they used to be. It’s a route that comes with guaranteed tax headaches and costs.
2. Option 2 (The Company-to-Company Direct Hit): Lending directly from Prince Tui Tech Ltd to Kornish Heat Ltd can neatly sidestep the immediate S455 tax and the personal Benefit-in-Kind issues for Tim. However, this is conditional on the loan being genuinely commercial, thoroughly documented, and the funds being used strictly for Kornish Heat’s business. The major watch-outs here are the high probability of getting no Corporation Tax relief for Prince Tui Tech Ltd if Kornish Heat Ltd (as a connected company) can’t repay the loan. Plus, there’s that lurking risk of the s464A Targeted Anti-Avoidance Rule if the arrangement isn’t structured with genuine commerciality at its heart.

Ultimately, there’s no one-size-fits-all “best” route without digging into the specific circumstances, risk appetite, and commercial realities for both Prince Tui Tech Ltd and Kornish Heat Ltd, but based on everything we have here, No Worries Accounting would point Tim towards option 2.

The Golden Rule: Document Everything!

If there’s one piece of advice that applies universally, regardless of which option Tim (or you) might lean towards, it’s this: get your paperwork in order. It isn’t just good housekeeping; it’s your best defence if HMRC ever comes knocking to ask questions about the loan.

Here’s what you should be looking at for each option:

1. If you go for Option 1 (Director’s Loan from Prince Tui Tech Ltd to Tim, then Tim to Josh):
2. A formal loan agreement between Prince Tui Tech Ltd and Tim, clearly stating the loan amount, any interest rate (even if it’s to match the ORI to avoid a BiK), and repayment terms.
3. Board minutes from Prince Tui Tech Ltd formally approving the loan to Tim and its terms.
4. A separate, clear loan agreement between Tim (in his personal capacity) and Josh, detailing the terms of their personal loan arrangement.
5. If you go for Option 2 (Company-to-Company Loan from Prince Tui Tech Ltd to Kornish Heat Ltd):
6. An inter-company loan agreement between Prince Tui Tech Ltd and Kornish Heat Ltd. This absolutely must specify all commercial terms: the loan amount, a commercial rate of interest, the repayment schedule, and any security being offered by Kornish Heat Ltd.
7. Board minutes from both Prince Tui Tech Ltd and Kornish Heat Ltd, formally approving the loan and its terms.
8. For Prince Tui Tech Ltd: Evidence of its commercial assessment before making the loan. This could include notes on Kornish Heat Ltd’s business plan, an assessment of the credit risk involved, and justification for the interest rate being charged. Essentially, Prince Tui Tech needs to show it considered why this loan was a reasonable commercial proposition for it to make.

Good records are absolutely vital and are your best defence. They demonstrate that you’ve considered the implications, structured the loan properly, and (especially for Option 2) that there’s a genuine commercial basis for the transaction.

Frequently Asked Questions

I’m a UK contractor. What’s the biggest tax trap if I lend money from my company to myself to fund a family business?

The biggest trap is usually Section 455 (S455) Corporation Tax. If you, as a director and shareholder of your own limited company (a “close company”), borrow money and it’s still outstanding more than 9 months and 1 day after your company’s year-end, your company has to pay HMRC 33.75% of that outstanding loan amount. For a £60,000 loan, that’s a £20,250 upfront tax bill for your company! While it’s reclaimable later, it’s a big hit to your cashflow.

Can I just repay a director’s loan before the S455 tax deadline and then borrow it again?

Of course not – what are you even thinking? HMRC is wise to this set-up, in fact it even has its own name, “bed and breakfasting.” They have anti-avoidance rules (like the “30-Day Rule” and the “Arrangements Rule”) to stop this. Repayments must be genuine and lasting (“enduring”) to avoid the S455 tax. Trying to quickly repay and redraw usually won’t work.

What’s the most important thing to do when my company is lending money to help a family start-up?

Make sure the start-up is legitimate and your family member is not trying to steal money off you 😊 The second most important thing is to document everything meticulously! Whether it’s a director’s loan (Option 1, generally best avoided) or a company-to-company loan (Option 2), you should get formal loan agreements, board minutes approving the loan and its terms, and (for Option 2) evidence of your company’s commercial assessment for making the loan. Good records are your best defence if HMRC asks questions.