Inheritance Tax Update from Lucy Orrow – Directors Loan Account

Lucy Orrow Tax Accountant Essex Lambert ChapmanPosted by Lucy Orrow:

Did you follow the herd at the turn of the decade and incorporate your sole trade or partnership?

The aim at the time was to reduce risk and increase security against creditors, which would still be true today.  In addition, the Entrepreneur’s Relief Capital Gains Tax rate of 10% was the lowest available rate for some time and matched its predecessor, taper relief and in some instances bettered it.  Entrepreneur’s Relief was available on certain business assets and back then, on goodwill.

Goodwill is often the biggest asset for a sole trader or partnership so following incorporation.  Having the option to write this off over time against profits, was another benefit.  The option to do this is however, no longer available.

As a benefit of incorporation, the Corporation Tax rates were starting to be reduced to encourage investment in the UK by Multinational Corporations.  Whether the Starbucks “fiasco” has tainted the original intention is still being determined.  It has not however, impacted on the low rates still available.  Remember, sole traders and partnerships are still suffering 20% to 45% tax on profits.

The incorporation of a business created a directors loan account for the proceeds of sale and this could be withdrawn over time, as required, in a tax efficient manner.

The original sole trade or partnership share would have been eligible for business property relief on the assumption that it was a trading business.  On incorporation, the shares held would also be eligible but the loan account becomes an asset in the estate liable to inheritance tax as it is effectively cash.  The value shift between the original business and the new shares and loan account could create significant inheritance tax exposure.

WHAT CAN BE DONE?

One suggestion would be to consider using the loan account balance to subscribe for redeemable preference shares.  If held for a minimum of 2 years, they will become eligible for business property relief (as for the ordinary shares) and can be redeemed out of profits.  This would necessitate the restriction of access to the funds for a two year period but could be a long term saving for estate planning purposes.

Please get in touch if this is something you would like to discuss in more detail.

October 2018

Disclaimer

The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.

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