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Director's loan account on winding up

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I'd be grateful if someone could settle a debate in the office.

A client ceased trading and has prepared cessation accounts to the end of the month in which they ceased trading. The client withdrew £20k during the year, but no dividends were voted, as there was a sufficient DLA balance to draw funds from (£60k). However, there were closing trade debtors of £35k which were paid into their personal account, and £25k cash at bank. The bank has already been closed and funds transferred to the director.

The primary reason for winding up is they are moving overseas, so at first glance condition D of TAAR seems to be satisfied, therefore the remaining reserves can be treated as a capital distribution. However, ctm36305 states "The purpose of ITTOIA05/S396B is to prevent individuals converting what would otherwise be a dividend into a capital payment, and so reducing their overall tax liability.". So the winding up isn't primarily to achieve a tax advantage, but the decision to not vote dividends is.

I have 2 questions:

1) Does the decision to not vote a dividend constitute failure of condition D, therefore cannot be treated as part of the capital distribution? The following ICAEW article states "HMRC has indicated that the decision not to pay out a pre-winding up dividend will not normally be regarded as tax avoidance for this purpose" but I can't find any guidance confirming this.

https://www.icaew.com/technical/tax/tax-faculty/taxline/taxline-2018/jul...

2) Assuming no to question 1, the effect of not voting a dividend is that the DLA becomes overdrawn post-year end. £60-20-35-25=£20k overdrawn. Is this to be treated as an income distribution per s.415 ITTOIA05 ?. I assume that not going through the formal liqudiation process and not drawing accounts up to later date does not change anything.

Thank you everyone in advance for your time and comments.

Replies (13)

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RLI
By lionofludesch
22nd Nov 2019 16:00

If the company has a £20k asset - the DLA - does it have liabilities ?

Or is this £20k represented by share capital and reserves ?

If the latter, I'm seeing this as £60k the company owed the director anyway + a £20k capital distribution.

However, your client has gone about this in a completely cackhanded way. Why couldn't he wait a few weeks and close down the company in an orderly fashion?

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Replying to lionofludesch:
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By jjameson
22nd Nov 2019 16:27

Thanks for your reply.

Agreed. They went ahead and closed everything down without running it by us first.

Other side of the balance sheet would be reserves.

The £60k is owed as at the year end, assuming dividends are voted to match drawings. Otherwise the DLA would be £40k as at the balance sheet date, but £20k overdrawn once trade debtors and cash at bank had been transferred.

If we do vote a dividend, DLA is nil and so is reserves.

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By SWAccountant
22nd Nov 2019 17:01

I'm not too familiar with the TAAR, but I know that TIS, which is similar in principle, operates on the basis of an income tax advantage arising as defined in the legislation. It doesn't look at motive - it looks at fact. Was there an advantage?

If the TAAR is similar and there are reserves, I would imagine there is an advantage (as you say, a dividend could be paid instead). I appreciate though that tax law doesn't always follow common sense.

This of course may or may not be helpful.

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Replying to SWAccountant:
RLI
By lionofludesch
22nd Nov 2019 17:15

There's probably no advantage to paying a dividend though, is there ?

A lot of assumptions involved but the tax on a gain of £20000 with ER is likely to be less than dividend tax on £20000. The difference isn't huge though (£800 ish as opposed to £1350 ish on the basis of a whole raft of assumptions).

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Psycho
By Wilson Philips
22nd Nov 2019 18:15

The test of the TAAR is not to consider whether or not the funds are distributed by way of a dividend - it is concerned with the winding up itself. In other words not how but why. And of course condition D is in point only if one or more of the others are. It doesn’t sound as though the individual will be involved in the same or similar business within the next 2 years. So you could probably stop there - if you even get there.

But in any event the TAAR applies only to a formal winding up so if you’re not going down the liquidation route the TAAR is of no relevance.

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RLI
By lionofludesch
22nd Nov 2019 18:16

It boils down to plaiting the sawdust which the client has left behind.

On the basis of earlier posts, one interpretation is that the director has overdrawn his account and then distributed that asset in specie in an informal liquidation.

Or - it could be that the loan has been written off, which would make it a distribution.

The director's intentions are probably what you'll have to rely on. Unreliable and uninformed though they are. If HMRC challenge whatever you decide, I'd probably be tempted to say, "OK fine" because the case isn't worth pursuing.

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Replying to lionofludesch:
Psycho
By Wilson Philips
22nd Nov 2019 18:27

Another interpretation is that the DLA has been cleared down and the balance of £20k distributed as a distribution in anticipation of application to strike off.

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Replying to Wilson Philips:
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By The Dullard
25th Nov 2019 10:31

I believe this is the line that HMRC are arguing these days. That the £20K withdrawal was a de facto distribution of the company's assets with no intention of either party to create a repayable debt. The absence of "paperwork" might not evidence a dividend, but neither does it evidence a loan.

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Replying to The Dullard:
Psycho
By Wilson Philips
25th Nov 2019 10:34

And since £20k is less than £25k ...

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Replying to Wilson Philips:
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By The Dullard
25th Nov 2019 11:06

Yes, but the £25K only applies if there is a dissolution and striking off under CA 2006, s 1000 or s 1003.

The OP seems to be have already had a formal liquidation (don't know why). If they hadn't, the TAAR wouldn't even be relevant. The suggestion is that it's all already been done.

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Replying to The Dullard:
Psycho
By Wilson Philips
25th Nov 2019 13:10

I couldn’t see any reference to a liquidation. The fact that he is referring to the TAAR suggests that a liquidation may have been involved but he wouldn’t be the first to think that it also applies to an informal striking off. I was assuming that he had made that same mistake.

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Replying to Wilson Philips:
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By The Dullard
25th Nov 2019 13:17

There are several references to a winding up, which is what a liquidation is. Dissolution and striking off under s 1000 or s 1003 isn't a winding up. Again though the OP could be confused with the terminology. Whatever's happened though, it does seem to have already happened.

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Replying to The Dullard:
Psycho
By Wilson Philips
25th Nov 2019 13:33

“I assume that not going through the formal liqudiation process and not drawing accounts up to later date does not change anything.”

I read that as meaning that there had been no liquidation, rather than suggesting an alternative course of action. But it wouldn’t be the first time that I’d jumped to the wrong conclusion.

And, yes, people do very often use “winding up” as a general term.

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