Peter Rayney looks at the potential 32.5% tax charge that can arise on management buy-out deal structures.
We will probably be familiar with the close company loan to participator tax charge in CTA 2010, s 455. Broadly, where a loan is made to a shareholder – typically where an overdrawn director’s loan account arises – that has not been cleared or repaid within nine months of the company’s year-end, the company must pay a 32.5% tax charge on the amount that remains outstanding.
Scope of CTA 2010, s 459
Perhaps less well-known is the supplementary provisions dealing with ‘indirect loans’ to shareholders (in CTA 2010, s 459). Broadly, this provision deems a loan to have been made to a participator (typically a shareholder) where:
- under arrangements made by someone,
- a close company makes a loan that is not within the normal CTA 2010, s 455 tax charge; and
- a person (other than the close company) makes a payment to a participator (or their associate), which is not subject to an income tax charge (CTA 2010, s 459(3)).
This legislation primarily aims to catch certain ‘back-to-back arrangements’ – such as where a close company deposits cash with (say) a bank on the understanding that the bank will make an advance or loan to a participator of that close company. These arrangements would firmly fall within this legislation.
However, the wording of CTA 2010, s 459 is sufficiently wide to catch ‘financial assistance’ type loans made in connection with management buy-out (MBO) deals. This is best illustrated through a typical MBO case study.
Case study – Management buy-out
Miss Olu, the 100% shareholder of BM Six Ltd has agreed to sell ‘her’ company to a new company (Newco) under an MBO deal, following the formation of Newco by Alan and the company’s senior management team.
Under the MBO deal, Miss Olu will sell her 100% holding in BM Six Ltd for £6 million, funded by surplus cash remaining in the business (i.e. surplus to its normal working capital requirements) of some £2 million, commercial bank debt of £2 million, deferred consideration of £1.5 million, and shares in Newco (worth £0.5 million).
The corporate finance adviser has indicated that the £2 million ‘surplus’ cash should be passed to Miss Olu by way of a loan from BM Six Ltd to Newco, as shown below:
Under the above proposals, the loan made by BM Six Ltd to Newco is not within CTA 2010, s 455 since it is not to an individual participator (shareholder). However, under the MBO arrangements, the £2 million loan monies form part of the £4 million sale proceeds immediately payable to Miss Olu (the seller) in an income-tax-free form. Consequently, CTA 2010, s 459(2) would apply to treat the loan made to Newco as though it were a loan to a participator within CTA 2010, s 455. Thus, if it was not repaid within the relevant ‘nine-month’ window, a section 455 charge of £650,000 (i.e. 32.5% x £2 million) would arise.
On the basis of the current deal structure, Miss Olu is a participator in Newco. However, even if she did not take shares in Newco as part of her sale consideration, she would be a participator by virtue of being a loan creditor (CTA 2010, s 454(2)(b)).
HMRC continues to confirm that where the relevant conditions are satisfied, it will seek to apply the CTA 2010, s 459 provisions.
Using dividends to transfer cash to Newco
In practice, it is often possible to ‘plan out’ of the potential CTA 2010, s 459 CTA 2010 problem by arranging for the monies to be transferred to Newco via a dividend payment (assuming the ‘business’ has sufficient distributable reserves).
The ‘tax-free’ dividend monies received by Newco are then used to discharge the purchase consideration payable to the sellers of Target. Since there is no loan to Newco, CTA 2010, s 459 cannot apply.
Practical Tip:
Where an upstream loan has already been used, a post-acquisition dividend could be used to repay the loan before the ‘nine-month’ trigger date for the 32.5% tax charge.
