Tony Granger critically examines whether it is worth business owners leaving their money in the business.
Almost every business owner will have invested money into their own business. Some will do it by buying shares in a limited company; others by lending the company money, which is reflected in their director’s loan account (DLA). Partners will fund the business through their capital accounts.
The above actions need to be differentiated from the business loaning money to the directors or partners, causing an overdrawn loan account, which may have adverse tax consequences.
Director’s loan accounts that are positive
Money paid into the company by way of loans to the company belongs to the director personally. On death, this loan account capital must be accounted for in his estate, and could be subject to inheritance tax (IHT) at the current rate of 40%. Whilst this capital may be used in the business as working capital, or to buy items for use in the business, it does not qualify for business property relief (BPR) from IHT.
The capital is treated as a loan made to the business, and interest may be paid to the director at a commercial rate. This interest would generally be deductible to the business but taxable in the hands of the director.
A client once told me that he sold his business as he was suffering from ill health. He left a DLA of over £700,000 in his former business, which would have cost him £280,000 in IHT had he died at the time. His reason – he had no immediate use for the money and thought he would leave it in the business.
Partnership capital accounts
A partner or LLP member’s capital account is an integral part of the business. On death, it is treated as a business asset and qualifies for BPR – so long as the conditions for BPR are satisfied. No IHT would generally then be payable.
Tip:
Investing in a partnership or LLP capital account could be a tax shelter from IHT. A commercial rate of interest could be earned on the capital. However, capital could be at risk of loss due to the unlimited liability of partners.
Repayment of a capital account on death
Where capital is employed in a business, on the death of a director, partner or LLP member, the business repaying the capital owing to the estate may be problematic. If no cash is available, nor credit (as a key person may have died, affecting the creditworthiness of the business), the business could have repayment difficulties and the deceased’s estate would still be liable for IHT on the money.
Practical Tip:
Plan carefully to avoid unnecessary IHT costs and future cash flow problems. Use life assurance to cover repayment of capital accounts, if possible.
It will always be preferable to ensure that capital is protected from unnecessary taxes – many directors believe that IHT will not affect director’s loan accounts that are positive – whereas this is not the case.
