HMRC are running a test case to challenge one of the traditional approaches of dealing with an overdrawn directors’ loan account (‘DLA’) when entering a Members’ voluntary liquidation (MVL). The issue applies when a shareholder ‘receives’ the benefit of a company’s loan debtor balance that it has with him on a liquidation. Normally we would want such a distribution to be taxed as capital in the shareholder’s hands but unfortunately HMRC have different ideas.
Steve is the sole shareholder of a company whose assets are worth £1M. This is comprised of £800,000 of cash and £200,000 DLA which is due from Steve. The proposal is to carry out an MVL of the company and distribute the £1M of assets to Steve.
Here we would traditionally say that Steve is subject to a capital gain (which may be subject to Entrepreneurs’ Relief) on the full £1M. I suppose that we are kind of saying that the loan has been ‘repaid’ through the capital distribution. Before the test case we believed this to be tacitly accepted by HMRC.
HMRC are now seeking to argue that £200,000 of the capital distribution constitutes a loan write-off and therefore under tax rules relating to such write-offs Steve should be subject to income tax as if he has received a £200,000 distribution. The tax rate here could be up to 38.1% which is unattractive compared to a 10% capital gains tax rate.
Hopefully further clarity on HMRC’s position will be issued over the coming months. In the meantime it makes sense to sidestep this issue where possible. We have been thinking about the following kinds of solutions:
This is a big issue which should not be ignored!
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