Shark-infested waters

Owners and directors of companies should beware the lasting effect of the new loan rules brought in under this year's Budget. The rules, which were brought in with immediate effect and no consultation, challenge previously established cash flow planning within companies.

One technique that directors and shareholders of small companies have used to help with their cash flow is using loan accounts. Directors can draw from a loan account during the year and repay it within nine months of the year end, possibly by way of declaring a dividend that is offset against the loan account rather than taken as cash from the company.

The repayment stops the company having to pay tax on the loan account (a tax that is repaid when the loan is repaid or written off by the company) and brings the withdrawal into the director's income tax computation, if it is a repayment through income such as a dividend. The timing can help with cash flow for the company and director's tax where these straddle different tax years, but it does not avoid tax.

HMRC felt that some people were abusing this process, for example repaying the loan to gain relief from the company's tax on the loan account then withdrawing it the next day. Therefore, HMRC put in place a mechanism to stop this so called 'bed and breakfasting' in the Budget. Unfortunately, this has also had the adverse effect of catching out those using loans from companies for legitimate cash-flow reasons, rather than seeking to avoid tax.

Rule change

The new rules discount the loan repayment to the company for tax relief purposes in the following circumstances:

• Simply, if loan repayments are made of more than £5,000 to a company and are then withdrawn again by way of loan within 30 days of the repayment.
• The additional and more complex rule brought in is that of 'intention': if there is an amount outstanding from a participator to a company of £15,000 or more, and at the time of the repayment there are either arrangements to redraw or an intention to redraw an amount from the company.

The second rule will catch out those owner-managed businesses (OMBs) that are not intentionally abusing the loan repayment relief. Consider the example of two directors in an owner-managed company: they have drawn on their loan accounts, repaid within nine months of the year end, but would draw on their loan again in the next month.

Alternatively, the directors' tax liabilities have historically been paid by the company through their loan account. They will then repay this after the year end. In both cases, there is an intention to draw monies in the future from the loan accounts, therefore relief for the company with respect to the loan repayment would be denied.

More than ever, directors and shareholders of companies need to plan throughout the year, as well as at year end, to ensure their actions have the intended consequences and do not accidentally trigger a tax liability for either the directors or the company.

Disincorporation considered

A positive change for OMBs, which took effect from 1 April 2013, is disincorporation relief. If the impact of maintaining a company's compliance is too much of a burden on those involved, they can consider 'disincorporation'. In effect, this means moving the assets into the hands of the shareholders that wish to carry on the business, as usually on liquidation there is a corporation tax charge where these assets are disposed.

Disincorporation relief was brought in to give relief against capital assets such as goodwill and certain land and property assets where their value does not exceed £100,000. There are other conditions to be met and other taxes still due, but this relief, which will be operational for five years, goes some way to assist those wishing to disincorporate their business.

Lucy Brennan is a partner at Saffery Champness

She writes a regular blog on tax and estate planning for Private Client Adviser