12 Jul 2018

Entrepreneurs under attack


Members’ Solvent Liquidations (“MVL”s) remain an invaluable tool to extract the surplus left in a company when it reaches the end of its useful life, typically where the owners are looking to retire and have either sold the core business and assets or simply ceased to trade.

The resulting distributions to shareholders are usually taxed as capital and attract a rate of 10% where Entrepreneurs Relief is available. Annual capital gains tax exemptions can bring that down to an effective rate of 9% or less, if distributions are split over tax years.

HMRC’s Radar

As you will have seen from previous blog posts, MVLs have been on HMRC’s radar lately in terms of both the Targeted Anti Avoidance Rules to clamp down on company phoenixes, and more recently a policy change resulting in 8% statutory interest on Corporation Tax and other Crown liabilities .

The latter was a personal bugbear – to say the least! - but I am pleased to say that the tables have been turned slightly. With the right planning, Corporation Tax paid on the day of liquidation itself and in advance of the normal due date, can attract a discount under provisions in the Insolvency Act covering debts paid early.

I will not bore you with the technical details, but we have avoided paying interest and secured refunds on several solvent liquidations. One of those amounted to £3,000 and covered the cost of winding-up!

Overdrawn Directors’ Loan Accounts to be Taxed as Dividends?

HMRC is now apparently trying to change established practice in relation to overdrawn director’s loan accounts (“DLA”).

The current, and very common practice, is to distribute the overdrawn loan in specie – in other words, in non-monetary form by way of a paper transaction. Where the directors and shareholders are one and the same, that avoids a pointless circular movement of funds.

However, HMRC is understood to be running a test case to challenge this approach, seeking to reclassify the distribution of the loan account as income rather than capital. This would enable HMRC to charge tax, in effect, at a potential rate of up to 38.1% as a dividend rather than at the 10% (if Entrepreneurs Relief applies) or 20% capital gains tax rates.

The real problem at this stage is a lack of anything concrete. I have seen reference to the test case as XYZ Limited but no further detail, nor are any changes proposed as far as I can see in the Finance Bill 2018-19: government releases draft legislation released on 6th July 2018.

The Twilight Zone?

As advisors faced with unsubstantiated but potentially key – and costly! - changes, the only thing that we can do is try to manage risk.

The safest option to avoid an overdrawn DLA distribution being treated as income by HMRC is for the director to repay the loan in full prior to liquidation. That could in theory be just before the winding-up takes effect, with the Liquidator making an immediate distribution to return the funds immediately on appointment.

The substance of the transactions is no different in my view to the current long standing procedure where the pointless circular movement of funds is avoided, but if a physical repayment is required - rather than in specie if that turns out to be the area HMRC are focusing on in the test case – then so be it.

The alternative is to use the existing cash left in the company on winding-up to make a capital distribution, which is then available to fund repayment of the DLA. Some commentators have even suggested this could be “rinsed and repeated”, where several distributions and repayments are made to fully extinguish the loan. That feels artificial, but may be the only answer where the director does not have alternative means.

These potential changes should not prevent solvent winding-ups from proceeding, but are a reminder of why it is imperative to get proper advice before planning an exit strategy for your company.

If you are considering entering an MVL and would like advice, please do get in touch with me.