Tony Granger looks at the Inheritance Tax implications of certain loans for Business Property Relief purposes for Tax Insider Lite.

Introduction

What is the Business Property Relief (BPR) position for Inheritance Tax (IHT) purposes of a Director’s loan account and that of a Partner’s or LLP Member’s capital account?  One qualifies for BPR, the other does not!

‘Positive’ Director’s Loan Account

A director’s loan account can be viewed in two ways. If the account is ‘positive’ (i.e., in credit) then the director loans money to the company. The money belongs to the director and could be repaid at any time, usually on demand.
 
The director’s loan account can originate from cash or assets loaned to the business, or remuneration and dividends not taken. The company can pay interest on the loan account money to the director, and this interest payment is normally a deductible expense to the business.

‘Negative’ Director’s Loan Account

If the director’s loan account is negative then the director owes money to the company. In this case, the outstanding loan will be taxable in the hands of the company if not repaid within 9 months of the accounting year end of the company (at a tax rate of 25%). When the loan is repaid, the tax paid can later be reclaimed by the company. 

Director’s Loan Account Not Qualifying for BPR

Many directors and shareholders have made loans to their companies. These will be shown in the company accounts as the directors’ loan account. It could be made up of loans made by the director or as a result of dividends or remuneration that hasn’t been drawn out of the company. If the director died, the loan would need to be repaid.

The ‘positive’ director’s loan account is seen as cash owned by the director (or shareholder) and is not treated as a business asset for BPR purposes, and is therefore an asset in the estate of the director on death and liable to IHT at 40%.

Some of these loan accounts are substantial – mainly because they support bank or finance arrangements in the business but could cause severe problems to the company if a director died and the loan account had to be repaid. 

Practical Tip 1

The company repays the loan account (or a proportion of it) and the director invests in IHT-protected investments. The company refinances the loan account and deducts loan interest payments. If the company did not have the money available to repay the loan, the director’s loan account should be covered with insurance to protect the company, the director and the director’s estate.

Partner's/LLP Member’s Capital Account Qualifies for BPR

A Partner’s or LLP member’s capital account, on the other hand, is seen to be an integral part of the business and is treated as a business asset on death, qualifying for Business Property Relief (BPR) on the death of the partner or LLP member. 

Usually BPR will apply to the capital account, with no IHT payable. However, watch out for any clause in the partnership agreement saying that a continuing partner will purchase a deceased partner’s share, as BPR will then not apply.

Practical Tip 2 

It is important that partnership and LLP agreements give the continuing partners an option to purchase rather than an obligation to do so.

Article Added Sunday, 13 February 2011 | 1534 Hits

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