It is normally a straightforward task to determine whether a close company has made a loan to a shareholder, for the purposes of a tax charge under CTA 2010, s 455 (previously ICTA 1988, s 419).
However, sometimes the position may become a little blurred. For example, what happens if company funds are held in an account in the company owner’s name, as opposed to the company itself (e.g. because the funds can earn a higher rate of interest in a personal account)? Are there implications for s 455 purposes?
Funds held 'on trust'?
In Mirror Image Contracting Ltd v HMRC  UKFTT 679 (TC), the company had built up cash balances from its business. One of the director shareholders withdrew surplus cash from the business, which he deposited in his personal savings account. He did this because business savings account interest rates were low, while personal savings account interest rates were considerably higher. The director shareholder claimed that the company account withdrawals were held by him ‘on trust’ for the company, and that he had subsequently repaid the funds.
Further withdrawals were made from the company account, and deposited in an offset mortgage account, which was held by the director shareholder and his partner (who was also a shareholder). He again claimed that the funds were held on trust for the company, would be paid back with interest when the company needed them, and that in the meantime the funds would be earning better interest rates than the company’s business savings account. However, the tribunal found that the funds originally withdrawn by the director shareholder, and the further withdrawals deposited into the joint offset mortgage account, were not held on trust for the company. In addition, the company had written off some of the withdrawals as bad debts. The question therefore arose whether the company was entitled to a deduction for the amounts written off as a trading expense. However, the tribunal found that the loans were outside the company’s trade, and that the profit and loss account deduction for the bad debt was not a trading deduction. This followed from principles established in case law (Curtis v J&G Oldfield  9 TC 319, and Bamford v ATA Advertising  4B TC 359). The tribunal held that the director shareholder’s withdrawal of cash from the company was not undertaken in the course of the company’s trading activities, and therefore a trading deduction could not be allowed for the debt going bad.
The withdrawals therefore fell to be treated as loans made by the company to participators, and a tax charge arose for the company under what was then ICTA 1988, s 419 (now CTA 2010, s 455). As an aside, it should be noted that no deduction is available to a company under the loan relationship rules where a loan which gives rise to a charge under CTA 2010, s 455 is released or written off (CTA 2009, s 321A).
Evidence is key
The tribunal’s comments in Mirror Image Contracting Ltd suggest that a ‘trust’ arrangement (whereby company funds are held in the account of a director shareholder on the company’s behalf) may avoid a charge on the company under the loans to participator provisions in CTA 2010, s 455. However, the tribunal commented that a trust arrangement would require the company’s funds to be kept in a separate account. Unfortunately for the director shareholders in
Mirror Image Contracting Ltd, the company’s funds had become “intermingled” with the director shareholders’ personal accounts. The legal effect of depositing funds into a mortgage offset account was to discharge a loan owed by the director shareholders. The tribunal said that if the company’s funds had truly been held on trust, this would have been
“an egregious breach of any trust”.
The concept of a person holding fund ‘on trust’ for another person or body is a legal one, which is beyond the scope of this article. However, based on the tribunal’s comments in the above case, if an individual is to hold funds on trust for a company, those funds would need to be kept entirely separate from any funds belonging to the individual. In addition, it would be sensible if documentary evidence of the trust arrangement was retained.
In the absence of such precautions, a close company runs the risk of a tax charge under CTA 2010, s 455, and there are potential benefit-in-kind implications for individuals who are directors or employees. Furthermore, if company funds become ‘intermingled’ with monies belonging to a company owner, it opens up the possibility that any enquiry into the
company’s tax return will be extended to the individual’s personal tax return, and/or an information notice for his or her bank statements if they are ‘reasonably required’ (under FA 2008, Sch 36, para 2). HMRC’s Enquiry Manual states the following in the context of close company enquiries (EM8508):
“When, at whatever stage in your enquiry, the directors personal finances become linked with the company enquiry you should make it clear you will examine the company and the director(s) finances together (observing as far as possible confidentiality) and that you will consider all the facts when seeking any settlement.”
The overall message is therefore that great care is needed in ‘trust’ arrangements involving holding funds on behalf of a company. Bear in mind that there may be non-tax, legal issues to consider as well.
Mark McLaughlin CTA (Fellow) ATT TEP