HMRC to change how they handle Overdrawn Directors Loan Accounts in MVLs

HMRC are running a test case to challenge one of the traditional approaches of dealing with an overdrawn Director’s Loan Account (‘DLA’) when entering a Members’ Voluntary Liquidation (‘MVL’).

At the end of a company’s useful life, if it is solvent, it is normal practice to place it into MVL to enhance the tax position of the shareholders by utilising Entrepreneurs’ Relief on the Capital Distribution.

At present if there is an overdrawn DLA at the start of an MVL the appointed IP could distribute this in specie (i.e. by paper transaction in a non-monetary format). This would avoid the director having to repay the loan in cash and then receive a sum back when distributed by the Liquidator.

The test case is aiming to reclassify the loan distribution as income rather than capital which means HMRC will be able to claim back a higher rate of tax, at the Dividend rate (presently up to 38.1%) rather than the usual 10% (if Entrepreneurs’ Relief is applicable) or 20% Capital gains tax rate. The income distribution will cause Entrepreneurs’ Relief to be lost which will result in an increase in the tax liability of the Shareholder. While HMRC claim this is just a test case, it is likely to become standard practice when the Finance Bill 2017 is passed through parliament.

There is also the possibility of HMRC claiming S.455 tax against the company if the DLA is not validly repaid within the required time limit.

What can be done?

To avoid an overdrawn DLA distribution being treated as income by HMRC, it is suggested that the director repay the loan in full.  This can be done prior to liquidation or from the cash capital distribution following liquidation, on the basis that the cash at bank is sufficient to cover the DLA. These and other HMRC changes to how MVLs are to be handled, are a reminder of why it is imperative to get proper advice before planning an exit strategy for your company.

If you are considering entering an MVL and would like advice please do get in touch