Section 455 loan charges in MBOs

The issue

Many of you will know about the CTA 2010 section 455 charge which kicks in when a company has made a loan to a participator which is not repaid within nine months of the year end. When this happens a section 455 charge is payable at 33.75% in respect of the year in question, although any such charge is repayable to the company nine months after the year end in which the loan is repaid or written off. This is why there is often a rush to clear loan balances before the section 455 charge is triggered. The rules are, however, more complex than this and can kick in in unexpected ways, such as when company funds are used to fund a management buyout (MBO).

CTA 2010 section 459 and ‘indirect loans’

This legislation deems a loan to have been made to a participator where:

1. Under arrangements made by a person
2. A close company makes a loan which does not give rise to a section 455 charge; and
3. A person other than the close company makes a payment to a participator or associate of a participator and they are not subject to income tax on this

This legislation can bite in unexpected circumstances.

Example

Jack and his wife own 50% each of their family trading company (Tradeco) which operates a carpet business. A value of  £10m has been agreed for the company and they have agreed an MBO structure with three key members of the management team. The deal involves them selling shares to Newco which will be funded as follows:

1. £3m surplus cash in Tradeco
2. £4m bank debt
3. £2m deferred consideration
4. £1m as shares in Newco worth £1m

It is proposed that the £3m of surplus cash will be lent to Newco to allow it to pay Jack and his wife. Here lies the problem. Under arrangements made by a person – Tradeco will be making a loan which does not give rise to a section 455 charge – and a different person than Tradeco (Newco) is making a payment to participators (Jack and his wife) which is not subject to income tax. On this basis, Tradeco would face a £1,012,500 charge under section 459 if the loan is not repaid within 9 months!

Forbes Dawson view

Although these circumstances are arguably outside the scope of the legislation, HMRC have confirmed that they will seek to apply the legislation in this way in appropriate cases. If reserves are available then this issue could be avoided by Tradeco transferring funds to Newco by way of a distribution rather than a loan. If sufficient reserves are not available then the issue can still be managed by ensuring that any loan is paid off by a distribution within 9 months of the year end.

 

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