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  • Neither a Close Company borrower nor a lender be – Part two

    2 October 2015

    Andy Wood

    In the first article we looked at some of the basics surrounding loans from Close Companies. This second and final part will look at ‘undoing’ the loan and some other interesting bits and bobs.

    What’s done cannot be undone? The ‘repayment, release or write off’ of loans

    So this brings us quite nicely on to ‘undoing’ a loan

    The tax code provides for a relief where the loan is repaid, released or written off. This means if the loan is undone prior to the expiration of the 9 month period then the s455 charge does not become due. If the loan is repaid after paying the s455 tax then one can recover the tax from HMRC.

    However, in addition, where a loan is released or written off then there is the potential for an income tax charge to fall fairly and squarely on the head of the Director Shareholder

    Therefore, if the Company tells the individual to ‘forget about the loan’, then this will result in he or she being deemed to have been in receipt of dividend distribution.

    How can the loan be undone without there being a tax charge?

    Well, the client could quite simply repay the loan out of his cold hard cash. Of course, that might go down like a lead balloon.

    The question is can any other type of asset be used to validly release the loan such that no tax charge results?

    Using assets to satisfy or clear the loan account – Collin v Addies

    It just so happens there is a useful case which considered the question of ‘release’ or ‘writing off’. This was the case of Collin v Addies.

    In this case, there were two Shareholder Directors outstanding to a Mr C and Mr G respectively. Our two heroes sold their shares in the Company to another chap, Mr B.

    In accordance with the sale, the Company, Mr C and Mr G, and Mr B executed a deed of novation. Under this deed, Mr B was substituted in their place as debtor to the Company.

    Like the good chap that he was, Mr B duly repaid the debt to the company.

    But guess what? HMRC then came along and assessed Mr C and Mr G under the predecessor section of the charge described above on the basis that this novation constituted a ‘release’ of the loan. Outrageous.

    It was argued for Mr C and Mr G that, and on first glance quite reasonably, ‘release’ was limited to a ‘gratuitous release’ of the loan. However, the Court of Appeal disagreed and found that had there been such an intention, then the legislator would have made that clear.

    Despite the fact that Mr C and Mr G were sent packing, there were some crumbs of encouragement which came out of this case. What is really interesting is that Nourse LJ agreed with HMRC’s concessions as to circumstances in which there would not be a release.

    This can be distilled down to the fact that:

    • Where an individual is indebted to a company and ceases to be so, then there will be a release, unless that release occurs as a result of the repayment of the loan itself.
    • However, the repayment can occur as a result of there being a payment by another party or as a result of the company accepting some other valuable consideration in kind. In such circumstances, the company is enabled to recover its money and so there is no justification for imposing a liability to tax on the participator.

    The Court clearly draws a distinction between a repayment and a novation of a loan.

    The key point is that such analysis may be beneficially deployed to help clear overdrawn directors loan accounts without creating an undesirable income tax charge. Of course, if one tells the Shareholder Director to settle his loan account using his main residence then we are back in lead balloon territory. However, it should be possible to utilise assets which are of less immediate use to the client.

    All the world’s at stage – Non-UK companies

    We will all be familiar with the phrase “if something is too good to be true then it probably is.” As an aside, I am always intrigued by the fact that this is always left open to some kind of doubt by the inclusion of the word ‘probably’ and the implication that some things which ‘are too good to be true’, aren’t so.

    Anyway, I think this is one such exception to the ‘too good to be true’ mantra.

    As stated at the outset of this article the 25% quasi corporation tax charge applies to ‘close companies’. However, the basic definition of ‘Close Company’ excludes non-resident companies. Surprisingly, and unlike many other anti-avoidance provisions, this definition is not extended to catch their foreign brothers and sisters. Therefore, a loan from a non-resident company will not be within the s455 charge.

    One does need to be careful that any such company is, first of all, properly non-resident. Even if it is, one needs to consider the transfer of assets abroad rules which can act to look through non-UK companies established for tax avoidance reasons. A discussion about these two issues is outside the remit of this article.

    A loan by any other name…

    If a Director Shareholder is contemplating the tax efficient methods of extracting funds from the business then he should sit down with his adviser and give it some proper thought. This should also include whether he needs the funds in his personal hands at all. In other words, can his personal or commercial objectives be met by using the value within the business without extracting the funds from the business wrapper at all? This can sometimes be the best route.

    However, the need is sometimes to literally put cash in to the client’s paws. If so, one should consider the normal routes of bonus, dividend and, lest we forget, loans.

    With that in mind, it does seem to me that it is quite possible to arrange a transaction which involves:

    • The Company advancing a capital sum to the Director Shareholder;
    • The Director Shareholder needs to pay back that sum under an obligation

    But that sum not be a loan within the provisions above. It should also be possible to structure it such that there is no taxable benefit for that individual.

    To EBT or not to EBT….Loans from EBTS and EFRBS

    Sure, I agree not strictly on topic. However, many SMEs will have established such arrangements over the past decades and will, in most cases, have taken loans from them. Due to legislation changes in December 2010, these are somewhat stuck in limbo.

    Despite, HMRC struggling to gain the upper hand in the Murray Holdings case (Rangers case), some of these might have been settled under the opportunity provided by HMRC.

    However, those which have not may be incurring significant ongoing benefit in kind charges and administrative fees going forward and perhaps without end.

    Again, it seems to me that many such arrangements can be unwind in a reasonably efficient manner and the trust.

    All’s well that ends well

    So, whilst perhaps the mantra ‘neither a close company borrower nor a lender be’ is a little excessive there are some key points to bear in mind.

    Firstly, one should ensure that one is aware of both the potential personal tax and corporation tax implications of making such a loan.

    Secondly, one should be mindful that writing off the loan (or otherwise invalidly releasing the loan) will result in a tax charge on the Shareholder Director.

    Thirdly, with that in mind, one should be comfortable that an overdrawn loan account can be cleared without creating a tax charge, but also without requiring the Director Shareholder dipping in to their pocket.

    So perhaps HMRC will not get that pound of flesh either…