| July 2006
Introduction
Business and commercial transactions invariably have tax consequences.
Unexpected tax liabilities can sometimes ensue. An example of this was
provided in the following recent Tax Forum query from 'bravo five',
involving the setting up of a new limited company and the issue of share
capital to its owners.
Q:
My partner and I set up a limited company a couple years ago. The authorised
and issued share capital was £10,000 split between the two of us.
My accountant is telling us we have to pay a Section 419 assessment on
the directors overdrawn account. The entries in our books were debit to
directors loan and credit share capital when the shares were issued for
no consideration. How can we avoid paying this as we have not physically
taken any money out of the business. Help!
A:
Editor's Comments
'Section 419' refers to specific tax legislation (ICTA 1988),
which is aimed at 'participators' (i.e. usually shareholders)
of 'close' companies (i.e. broadly closely-controlled companies,
such as family or owner-managed businesses). The effect of these rules
is that if a shareholder receives a loan or advance, the company is liable
to tax equal to 25% of the amount outstanding for the accounting period.
However, the tax need not be paid if the loan has been repaid, released
or written off within nine months and one day following the end of the
accounting period. If the loan or advance is repaid, released or written
off more than nine months after the end of the accounting period in which
the repayment, release etc takes place, the tax can be repaid nine months
after the end of the accounting period in which the repayment, release
etc takes place.
Any release or writing off of the loan is generally treated as though
the participator had received a net dividend from the company equal to
this amount. Income tax liabilities can therefore arise in the case of
higher rate taxpayers. There can be other income tax and national insurance
consequences to beneficial loans from the company as well.
There are some exceptions to the s 419 provisions. Examples include loans
from money lending companies, or if the debt arose for the supply of goods
or services in the ordinary course of the company's trade, unless
the credit given exceeds six months or is longer than is normally given
to the company's customers.
In the case of 'bravo five' above, shares to the value of
£10,000 have been issued, apparently without payment being made.
This can be sufficient to trigger a s 419 liability. It is not clear why
so much share capital was required. Very often in small companies, the
issued share capital is only (say) £100 in total.
'Bravo five' (and other taxpayers in a similar situation)
should seek advice from an experienced and qualified professional on how
to deal with the potential s 419 charge in the most tax-efficient way
for themselves and the company.
Responses from contributors included:
'Hashman' commented:
You can't - unless you pay the money you owe to the company - even then
you may be late in respect of year 1. Loans need to be repaid within 9
months of the year end to avoid the charge.
Can you not pay yourselves a dividend and use the money to repay the
debt?
BTW - why did you opt for such a large amount of issued share capital
when you've put nothing into the company. How did the company meet its
start-up costs?
'King Maker' commented:
Why did your accountant not make you aware of this potential problem?
There is also a Benefit in Kind charge if a loan exceeds £5000.
Is yours 2 x £5000?
'Hashman' commented:
.... and a class 1A NIC charge!
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