How can loan notes save you tax?
A competitor has made you an offer you can’t refuse for your company, but wants to pay you off with a mixture of cash and securities. Will the latter put you at a tax advantage or disadvantage?
A bird in the hand
“A bird in the hand is worth two in the bush” is often sound advice. But sometimes you don’t have that choice. For example, if you’re selling your company, it’s common for the purchaser to offer you a mixture of cash and shares in their company. This can cut down the amount of money they need to find immediately. But even if they are willing to pay you cash in full, you might be better off, tax-wise, by deferring some of the money you receive.
Securitised loans
One way of deferring proceeds from selling your business is to use a securitised loan, known as a loan note. That sounds fancy, but essentially it means that rather than the loan being repayable in instalments, it’s treated more like stocks or shares, i.e. the loan remains fully outstanding until such time as you decide to cash some of it in. Usually you would agree with the buying company the maximum you can cash in at any one time and the rate of interest they’ll pay you on the loan notes.
Qualifying Corporate Bond
As long as the loan note isn’t in a foreign currency, and can’t be converted or exchanged for shares in the buying company, the Taxman will treat the securitised loan as a Qualifying Corporate Bond (QCB), and they can offer a neat tax break.
Example - part 1. John is a shareholder/director in Acom Ltd, a manufacturing business. In January 2011 a competitor wants to buy Acom and offers John £900,100 cash for his shares. If he accepts, he’ll pay Capital Gains Tax (CGT) on the proceeds of £90,000 worked out as follows:
| £ | |
| Proceeds from shares | 900,100 |
| Less: cost of shares | 100 |
| Gain liable to CGT | 900,000 |
| Less: Entrepreneurs’ relief 4/9 of gain | 400,000 |
| Less: Annual CGT exemption | 10,100 |
| Chargeable to CGT | 489,900 |
| Tax due on gain at 18% | 88,182 |
Spreading the tax bill
John could, for example, take half the money in cash, and half in loan notes that meet the conditions for a QCB. His CGT bill on the cash element would be reduced to just under £43,200 (see The next step). And the special tax rules for QCBs mean the rest of the tax is deferred and only becomes payable when John cashes some of the loan notes. If he does this over several years, he can save tax.
Example - part 2. John cashes in the £450,050 loan over five years. Assuming the CGT rate and annual exemption remain the same, his tax bill for each year would be about £7,200. At the end of the five years John’s total CGT bill would be £79,200 (£43,200 + (£7,200 x 5 years)). That’s a saving of £9,000 compared to an all cash deal for his shares. This is achieved because John can use his annual exemption to reduce the CGT bill in each of the five years in which he cashes in the loan.
Tip. John should make sure that the terms of the loan notes allow him to transfer them. If he was married, he could give some loan notes to his wife. She could use her annual exemption against the tax bill. Over five years that could save another £4,000 CGT (see The next step).
For the workings behind the examples above, visit http://tax.indicator.co.uk (TX 10.14.04).
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