Do club membership loan schemes work?

The issue

It is fairly common for sporting clubs to seek cheap finance from its members for various initiatives (e.g. new tennis courts for a tennis club or a new irrigation system for a golf club). In a simple case this could involve a loan from a member where interest is charged at a rate of anything from 0% up to a commercial rate. In these circumstances the tax implications are very simple and simply involve the club paying interest under deduction of 20% basic rate income tax and the member including the gross interest in his or her tax return.

Often clubs employ ‘loan schemes’ which are more complicated than the scenario outlined above. These involve loans that are inextricably intertwined with member benefits.

Example

Royal and Ancient Golf Club needs £40,000 to buy a new tractor and Deacon Syme, one of its members, is prepared to provide the finance. The plan is for him to provide an ‘interest-free’ loan of £40,000 to the club, although the club will waive his annual subscription fee (normally £2,500) for the period when the loan is in place. Deacon Syme thinks that this is a great deal because it doesn’t occur to him that he may have to pay tax on the £2,500 benefit, and as a 45% tax payer he normally has to earn gross income of £4,545 to pay for his golf fees. In his head he is therefore effectively enjoying a 13.89% gross return on this loan.

The big question is whether the Deacon is correct in his analysis. Up to 2013 many clubs operated these kinds of schemes, and no tax was charged broadly on the basis that although the free membership period may look like interest it wasn’t technically interest and so was not reportable.

‘Disguised interest’ rules

The position became less clear when new ‘disguised interest’ rules were introduced in Finance Act 2013 which can now be found in section 381A of the 2005 income tax act. This legislation seems to be aiming to bring Deacon Syme’s membership benefit within the charge to taxation. It concerns amounts which are “economically equivalent to interest” and says that this will be the case if the following conditions apply:

1. It is reasonable to assume that it is a return by reference to the time value of money.
2. It is at a rate reasonably comparable to what is (in all the circumstances) a commercial rate of interest, and
3. When the person becomes party to the arrangement there is no practical likelihood that the return will stop being made.

Arguably, the fee savings in the example above are “economically equivalent to interest” and so Deacon Syme should be assessing himself to tax on £2,500 under these rules.

Our view

These loan schemes have been around for a while, but I just wonder how many clubs or members are aware of the ‘disguised interest’ legislation. Clearly any tax liability on the membership benefit would make the arrangement less attractive. Anecdotally, I have heard of some clubs who implemented the scheme up to 2013 but then stopped it when the new rules came in. Perhaps these rules would not apply to a scenario whereby there is no guarantee at the time of the loan that the membership fee would be waived, however HMRC may infer that there was a constructive obligation in cases where the fee waiver does take place. One idea could be for a member to seek non-statutory clearance about whether HMRC would apply these rules, although generally they would not want this hassle for relatively small amounts.

The weekly Tax Bites are not intended to constitute tax advice. The information provided in these articles is based on our understanding of current tax law; however, we do not represent or warrant the accuracy of the information contained therein, and any information provided may be incomplete or condensed. Furthermore, the suggestions contained within these articles are for discussion purposes only and should not be relied on. You should seek formal tax advice before proceeding with any of the suggestions contained in this document