It is not an uncommon ‘exit’ strategy for retiring shareholders to sell their shares to a newly-formed holding company. This can happen in management buyout (MBO) situations, or possibly for tax or commercial reasons of the purchaser.
For example, ‘Holdco’ may offer shares or cash to all shareholders of ‘Tradeco’, with the exiting shareholder(s) of Tradeco taking cash, and any remaining shareholders taking shares in Holdco. The share sale is often financed by a loan from the target company to the holding company. As an aside, apart from any company law considerations, for tax purposes it will generally be appropriate to seek clearance from HMRC under ITA 2007, s 701 and TCGA 1992, s 138 in respect of the ‘Transactions in securities’ and ‘Share-for-share exchange’ rules respectively.
The tax charge on close companies under the ‘loans to participators’ rules (TA 1988, s 419) is relatively well known and understood. However, the potential for a section 419 charge is less well known in respect of loans between companies. Section 419(5) states:
“(5) Where, under arrangements made by any person otherwise than in the ordinary course of a business carried on by him—
(a) a close company makes a loan or advance which, apart from this subsection, does not give rise to any charge on the company under subsection (1) above, and
(b) some person other than the close company makes a payment or transfers property to, or releases or satisfies (in whole or in part) a liability of, an individual who is a participator in the company or an associate of a participator,
then, unless in respect of the matter referred to in paragraph (b) above there falls to be included in the total income of the participator or associate an amount not less than the loan or advance, this section shall apply as if the loan or advance had been made to him”.
Applying those conditions to the earlier example:
- Tradeco has made a loan that does not result in a tax charge under section 419(1);
- ‘Some other person’ (i.e. Holdco) makes a payment to a participator in the company; and
- The loan does not become income of the participator (e.g. as a dividend).
On the face of it, a 25% charge potentially arises for Tradeco, unless the ‘loan’ is repaid within nine months and a day following the end of the accounting period.
The charge is not widely applied by HMRC, but it is an issue that they are aware of (see the Company Taxation Manual at paragraph 61670).
Preventing the charge
Depending on the circumstances, it may be possible to structure the share sale in such a way that the potential for a section 419 charge does not arise. If this is not possible, or if the deal has already taken place, consideration could be given to whether ‘Tradeco’ (in the above example) could pay a dividend up to Holdco during the above nine month period, to enable the loan to be repaid. Of course, this will depend upon such issues as Tradeco having sufficient distributable reserves.
The above article is taken from ‘Practice Update’, a bi-monthly Newsletter from Mark McLaughlin Associates Ltd. See the Newsletters section.