Most of you will know about the tax issues surrounding overdrawn directors’ loan accounts, but it is fairly common for shareholders to have loan accounts that are in credit (where they have lent funds to the company). An acquiror of a company will generally want to remove such a debt as part of a transaction and we have seen ‘heads of terms’ which suggest that such debts should be written off as a preliminary step. This will usually be a mistake because such a write-off would be booked as a profit in the company’s accounts, and this would in turn be subject to corporation tax at 25%. Furthermore, such a write-off would usually not give rise to any tax relief in the hands of the shareholder. No capital loss can generally arise on the non-recovery of a loan in the lender’s hands and the special relief available for loans to traders is only available when a loan becomes irrecoverable (and there are strict rules around this). This is therefore quite an inefficient tax thing to do.
What should be done? It is relatively simple to avoid these inefficiencies. The purchaser could simply pay less for the company and procure that the loan to the shareholder is repaid, or the loan could be assigned to the purchaser (which amounts to much the same thing).
Example: James has lent £2m to his company Q Gadgets Ltd and Blofeld Enterprises Ltd has offered to pay £6m for the company without the debt. The initial proposal is that the loan with James should be waived before the transaction. If the loan were waived, then James would receive £6m (assume £4.56m after CGT) and the company would face a £0.5m tax bill in respect of the loan write-off. Compare this to a transaction whereby James is paid £4m for the company (assume £3.04m after capital gains tax) and is also paid £2m from Blofeld Enterprises Ltd to assign the debt. The second approach leads to James receiving £5.04m proceeds rather than £4.56m and also avoids an unnecessary £0.5m corporation tax charge in the company.
A similar result can be achieved if James had capitalised the £2m loan by subscribing for share capital.
Our view: This is a great example of how it is very easy to ‘get tax wrong’ in transactions. This reminds me of transactions I have seen where an overdrawn loan account is written off prior to a transaction. This leads to the shareholder being subject to income tax on the write-off and there can also be difficult questions around whether employer’s NIC needs to be paid by the company. It is generally much better for the buyer to acquire the company including the benefit of the debtor balance within the purchase price, with the debt repaid by the seller out of their proceeds. In this way, the shareholder will effectively pay CGT rates on the value of the loan and there will be no need to worry about things like NIC. These kinds of things are quite simple but are often not properly considered unless proper tax advice is taken.
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Avoid shareholder debt write-offs in corporate transactions
An easy way to go wrong.
Most of you will know about the tax issues surrounding overdrawn directors’ loan accounts, but it is fairly common for shareholders to have loan accounts that are in credit (where they have lent funds to the company). An acquiror of a company will generally want to remove such a debt as part of a transaction and we have seen ‘heads of terms’ which suggest that such debts should be written off as a preliminary step. This will usually be a mistake because such a write-off would be booked as a profit in the company’s accounts, and this would in turn be subject to corporation tax at 25%. Furthermore, such a write-off would usually not give rise to any tax relief in the hands of the shareholder. No capital loss can generally arise on the non-recovery of a loan in the lender’s hands and the special relief available for loans to traders is only available when a loan becomes irrecoverable (and there are strict rules around this). This is therefore quite an inefficient tax thing to do.
What should be done? It is relatively simple to avoid these inefficiencies. The purchaser could simply pay less for the company and procure that the loan to the shareholder is repaid, or the loan could be assigned to the purchaser (which amounts to much the same thing).
Example: James has lent £2m to his company Q Gadgets Ltd and Blofeld Enterprises Ltd has offered to pay £6m for the company without the debt. The initial proposal is that the loan with James should be waived before the transaction. If the loan were waived, then James would receive £6m (assume £4.56m after CGT) and the company would face a £0.5m tax bill in respect of the loan write-off. Compare this to a transaction whereby James is paid £4m for the company (assume £3.04m after capital gains tax) and is also paid £2m from Blofeld Enterprises Ltd to assign the debt. The second approach leads to James receiving £5.04m proceeds rather than £4.56m and also avoids an unnecessary £0.5m corporation tax charge in the company.
A similar result can be achieved if James had capitalised the £2m loan by subscribing for share capital.
Our view: This is a great example of how it is very easy to ‘get tax wrong’ in transactions. This reminds me of transactions I have seen where an overdrawn loan account is written off prior to a transaction. This leads to the shareholder being subject to income tax on the write-off and there can also be difficult questions around whether employer’s NIC needs to be paid by the company. It is generally much better for the buyer to acquire the company including the benefit of the debtor balance within the purchase price, with the debt repaid by the seller out of their proceeds. In this way, the shareholder will effectively pay CGT rates on the value of the loan and there will be no need to worry about things like NIC. These kinds of things are quite simple but are often not properly considered unless proper tax advice is taken.
