New tax traps for members’ voluntary liquidations

Two changes of policy by HMRC mean that business owners and their advisers need to be on their guard when completing a solvent winding-up through a members’ voluntary liquidation (MVL).

MVLs are widely used when business owners retire or as a mechanism to unlock the underlying value of the business. They have long proved a tax-efficient way to recognise this value and distribute it to shareholders.

Change No.1: interest on future tax debts
The due date for paying corporation tax to HMRC is nine months and one day after the end of the accounting period. Where corporation tax was payable in an MVL, HMRC has previously only charged interest from that due date, applying the late payment rate of 3%.

Recently HMRC has started to rely on  principles emerging from the Lehman Brothers court case, namely  that statutory interest is payable on future and contingent debts from the date of an administration or liquidation.

As a result, HMRC is now claiming statutory interest – at the rate of 8% – from the date an MVL commences. This 8% will be charged even if the corporation tax due date hasn’t yet arrived. The same approach would appear to apply to all other taxes payable at a future date, such as PAYE and VAT.

How to respond
Business owners will not want to pay any interest. Therefore, the best approach is to calculate and pay any tax for periods that have closed before entering the MVL – whether or not the taxes are actually due yet.

In many cases, however, it may not be possible to know for certain how much tax will be payable for the final tax period leading up to the commencement of the MVL. In such cases, it would be sensible to estimate the expected tax liabilities and make a payment on account before entering the MVL. It may even be worth overpaying to minimise the risk of interest being charged, recognising that the insolvency practitioner (IP) will be able to reclaim any overpayments and then distribute them to the shareholders.

Change No.2: overdrawn director’s loan accounts
HMRC is also trying to change established practice in relation to overdrawn director’s loan accounts. Where an overdrawn director’s loan account was in place at the start of the MVL, it was standard practice for the IP to distribute this in specie (i.e. in non-monetary form via a paper transaction), rather than the director having to repay the loan in cash and then receive a distribution of the cash balance back from the IP. 

HMRC is now running a test case to challenge this approach – seeking to reclassify the distribution of the loan as income rather than capital. This would enable HMRC to charge tax at a potential effective rate of 38.1%, rather than at just 10% or 20%. Regardless of the outcome of the test case, the new position seems likely to be enshrined in law when the Finance Bill 2017 finishes its passage through Parliament.

How to respond
To avoid the risk of the in specie distribution being treated as income, any directors with an overdrawn loan account would need to pay back those loans.

Assuming there is sufficient cash in the business, the liquidator could first make a cash distribution (ideally of a sum at least equal to the loan). The director/shareholder with the overdrawn loan position would then pay back the loan to the IP, who would then settle the director's loan account before distributing the cash back to the shareholder.

If there isn't enough cash in the business, the directors would need to find the cash from other sources in order to settle their overdrawn directors' loan accounts and avoid paying income tax on any outstanding balance.

Plan ahead
These two changes in HMRC’s approach to MVLs serve as a timely reminder of the need to plan ahead and seek insolvency expertise, even in what may be apparently standard, simple situations.

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