Discharge of a director’s loan account on liquidation is not a write-off!

The issue

There have been various rumours circulating about a HMRC ‘test case’ with the following key points:

  1. A director’s loan account is discharged by way of a liquidation distribution.
  2. The shareholder treats this as a capital receipt.
  3. HMRC argue that it is an income receipt which is subject to dividend tax rates.
  4. Here HMRC would have to argue that in reality the loan had been written-off.

This perceived problem had various workarounds which could be administratively tedious but were worth doing in order to side-step the HMRC issue. One possibility was for cash distributions to be drip-fed to the shareholder allowing him to repay the loan account, after which that cash could be paid as a capital distribution.

New guidance

I was recently alerted to the following HMRC guidance (thanks to Steve Markey at Leonard Curtis who will receive a beer):

www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm61559

This may be HMRC’s attempt to ‘quietly’ address the rumours that have been flying around. Anyway, whatever the reason for it, it seems that HMRC now accept (and may well always have accepted) that if a shareholder debt is distributed to the shareholder in the course of a liquidation then it is not a write-off and therefore can properly be treated as a capital receipt.

Example

The issue is apparently put to rest in the example which HMRC provides:

A participator owed the company £1,425,000 by 30 May 2017. The company went into Members Voluntary Liquidation on 1 June 2017. The net assets, including the overdrawn loan account totalled £5,300,000.
On 1 June 2017 the liquidators declared an interim distribution in the liquidation of £1,425,000 per £1 ordinary share, giving a total distribution at that date of £1,425,000. This was not paid out in cash to the shareholder but was credited to his loan account. It would be a capital distribution within TCGA92/S122. This is not a release of the loan, it is a repayment of the loan. There can be no charge under ITTOIA05/S415.


Likewise any further distributions in the liquidation up to the total balance of the net assets will also be capital distributions.

Forbes Dawson comment

Liquidators should be able to take comfort from this useful clarification. Recently liquidators and shareholders have been concerned about the risk of an income tax charge and have often spent time coming up with fiddly workarounds. To be prudent liquidators may still want to minute the fact that the capital distribution due to the shareholders is being used to offset the loan – as this is consistent with HMRC’s example above.

 

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