- Churchill Tax
Writing Off A Loan To A Company
A few years ago you lent your son money to help get his new business off the ground. It’s now established but he can’t afford to repay you. You decided to waive the loan but are there any tax consequences you need to be aware of?
Corporation tax
There are several tax problems associated with waiving a loan to a company. Starting with corporation tax (CT), the loan relationship rules create a tax charge on profits companies make from money not directly related to their trade. If a company borrows money and the lender waives all or part of the debt, this is taxable as a loan relationship credit.
Inheritance tax
CT is not the only tax you have to worry about. If you waive any loan your estate becomes worth less. If the loan is to another individual, it’s a potentially exempt transfer (PET) meaning there’s no immediate inheritance tax (IHT) charge. One only arises if you die within the following seven years. However, waiving a company loan is a chargeable lifetime transfer (CLT) and IHT is payable at 20% on the value of the transfer in excess of the nil rate band (NRB) (currently £325,000).
TRAP:
Even if a loan waiver by itself doesn’t exceed the NRB, it has to be aggregated with other CLTs and PETs made within seven, and sometimes 14, years and so can create or increase the IHT bill on your estate (yr.15, iss.8, pg.7, see The next step ).
Capital gains tax
If you lend money to a close company (broadly, one that’s controlled by five or fewer individuals) that carries on a trade and waive the loan , it counts as a capital gains tax (CGT) loss. This can be used to reduce tax payable on capital gains in the same year as the loan write-off/waiver or, if you don’t have any gains in that year, those of any later year.
TRAP:
A capital loss only occurs where the loan is irrecoverable, i.e. the company can’t afford to repay it. If you waive a loan voluntarily you aren’t entitled to capital loss relief.
TIP:
Instead of waiving the loan, exchange it for new shares in the company. This solves most of the tax problems mentioned.
Corporation tax avoided
If a company gives something, e.g. shares, in return for not having to repay a loan, this doesn’t count as a loan relationship credit. To achieve this the company can create a new class of ordinary shares and issue them to you in exchange for the loan being written off (see The next step ).
Inheritance tax avoided
By swapping the loan for company shares of an equivalent value, there has been no loss in value to your estate so no CLT. Better still, the newly created ordinary shares can qualify for IHT business property relief (BPR). That means if you still own them at the time of your death and they meet the conditions for BPR, they’ll escape IHT entirely.
By swapping the loan for company shares of an equivalent value, there has been no loss in value to your estate so no CLT. Better still, the newly created ordinary shares can qualify for IHT business property relief (BPR). That means if you still own them at the time of your death and they meet the conditions for BPR, they’ll escape IHT entirely.
Capital loss relief regained
And finally, if the company falters and you sell your shares for less than their original value, or they become of negligible value but you don’t sell them, you’ll be entitled to CGT loss relief which you can use against your capital gains.