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Peter Rayney looks at the potential 33.75% tax charge that can arise on many management buyout deal structures. 

The close company loan to participator tax charge (in CTA 2010,s 455)is a reasonably well-known part of our tax code.  Broadly, where a loan or advance is made to a shareholder – typically where an overdrawn director’s loan account arises – that has not been cleared or repaid within nine months of the company’s yearend, the company must pay a 33.75% tax charge on the amount that remains outstanding.  In practice, many overdrawn loan accounts are cleared by the company making a bonus payment or a dividend payment to the director-shareholder within the nine-month repayment ‘window’.   
 
The section 455 charge is effectively an anti-avoidance provision. Without it, shareholders would simply be able to extract cash from ‘their’ companies, without a tax charge, by procuring the making of suitable loans to themselves. Thus, section455 triggers a deemed corporation tax charge of 33.75% – which is payable by the company – to the extent that the loan is not repaid or cleared within the relevant nine-month date (which, of course, coincides with when most companies pay their corporation tax).  
 
Section 455 tax is repayable to the extent the loan is subsequently repaid. However, if the loan is repaid after the nine-month period ends, the tax refund only becomes due from HMRC nine months after the end of the accounting period in which the loan is repaid.  

Importantly, section 455 tax is deemed to be corporation tax. Thus, despite the fact that it is repayable, it is subject to tax-based penalties (for example, failure to disclose a section 455 tax charge in the corporation tax return). 

Scope of section 459 
Perhaps less known are the supplementary provisions dealing with ‘indirect loans’ to shareholders in CTA 2010, s 459.  Broadly, this provision deems a loan to have been made to a participator (typically a shareholder) where: 

●its under arrangements made by someone;  

●a close company makes a loan that is not within the normal CTA 2010, s 455 tax charge (e.g., a loan to a company); and 

●a person (other than the close company) makes a payment to a participator (or their associate), which is not subject to an income tax charge (CTA 2010, s 459(3)). This would be the case, for example, where the participator or their associate receives the money under the capital gains regime. 

This legislation primarily aims to catch certain ‘back-to-back arrangements’ – such as where a close company deposits cash with (say) a bank on the understanding that the bank will make an advance or loan to a participator of that close company. These arrangements would firmly fall within this legislation.  

However, the wording of CTA 2010, s 459 is sufficiently wide to catch ‘financial assistance’ type loans made in connection with management buyout deals.  This is best illustrated through a typical management buyout (MBO) case study. 

MBO case study 
Miss Eagle, the 100% shareholder of BigskiLtd, has agreed to sell ‘her’ company to a new company (Newco) under an MBO deal, following the formation of Newco by Michael and the company’s senior management team.  

Under the MBO deal, Miss Eagle will sell her 100% holding in Bigski Ltd for £6m. The £6m sale consideration would be funded by surplus cash remaining in the business (i.e., surplus to its normal working capital requirements) of some £2m, commercial bank debt of £2m, deferred consideration of £1.5m, and shares in Newco (worth £0.5m).  

The corporate finance adviser has indicated that the £2m ‘surplus’ cash should be passed to Miss Eagle by way of a loan from Bigski Ltd to Newco, as shown below: 

Under the above proposals, the loan made by Bigski Ltd to Newco is not within CTA 2010, s 455, since it is notto an individual participator (shareholder). However, under the MBO arrangements, the £2m loan monies form part of the £4m sale proceedsimmediately payable to Miss Eagle (the seller), which would fall within the capital gains taxregime (i.e., an incometax-free form).   

Consequently, CTA 2010, s459(2) would apply to treat the loan made to Newco as though it were a loan to a participator within CTA 2010, s 455. Thus, if it was not repaid within the relevant ‘nine-month’ window, a section455 charge of £675,000 (i.e., 33.75% x £2m) would arise.   

On the basis of the current deal structure, Miss Eagle is a participator in Newco.  However, even if she did not take shares in Newco as part of her sale consideration, she would be a participator by virtue of being a loan creditor (CTA 2010, s454(2)(b)).    
HMRC continues to confirm that where the relevant conditions are satisfied, it will seek to apply the CTA 2010, s 459 provisions. 

Using dividends to transfer cash to Newco 

In practice, it is often possible to ‘plan out’ of the potential CTA 2010, s459 problem by arranging for the monies to be transferred to Newco via a dividend payment. Proper procedures would have to be followed to ensure that the ‘target’ company makes a legally compliant dividend. For example, the target’s directors would need to be satisfied that it has sufficient distributable reserves to ‘frank’ the relevant dividend payment.  

The dividend monies received by Newco would be exempt from tax in Newco’s hands under CTA 2009, Pt 9A. These monies would then be used to discharge the purchase consideration payable to Miss Eagle on completion and at later dates. However, since no loan has been made to Newco, CTA 2010, s459 cannot apply.   

Practical tip  

Where an upstream loan has already been used, a post-acquisition dividend to the new holding company could be used to repay the loan before the ‘nine-month’ trigger date for the 33.75% tax charge.