What's so bad about bridging loans in a section 162 incorporation?

The use of bridging loans in a s162 incorporation have recently incurred the wrath of tax blogger, Dan Neidle (famous for exposing the tax affairs of Nadim Zahawi, among other issues).

The issue

Mr. Neidle brought these to light in the context of an incorporation scheme promoted by Property 118. Furthermore, just last week, the bridging loan scheme was subject to a stop notice from HMRC.

Our understanding of the gist of how this "scheme" works is as follows:

1. In order for a s162 property incorporation to be effective for capital gains tax purposes, all consideration must consist of shares in the recipient company.
2. The ability to defer any gain is reduced to the extent that there is any non-share consideration.
3. Technically, the assumption of a liability is non-share consideration and so would frustrate the full relief under the strict wording of the legislation.
4. This is where extra statutory concession (ESC) D32 comes in. ESC D32 broadly says that business liabilities will not restrict the relief... but it is a concession with no legislative basis.
5. For example, it is broadly accepted that mortgages in a property business can have protection from the ESC.
6. The "bridging loan scheme" tries to take advantage of ESC D32 to address a particular problem that can arise in incorporations.
7. One condition of s162 TCGA1992 is that all assets of the business (except cash) need to be transferred to the company.
8. Often the business owner’s capital is tied up in the assets of the company, and this can particularly be the case for property businesses.

Example

In 2017, Steve put £1m of capital into a property business and bought £1m of property with it. He has since also reinvested all of the net rental income in more property. Steve currently has £1.4m of capital invested in the business (the original £1m and £400,000 of net profit) and the property is now worth £2m. He wants to incorporate but does not want to "lock up" his capital in the company.

To avoid this problem, Steve plans to take a £1.4m bridging loan whereby the business would take on £1.4m of business liabilities and he would withdraw £1.4m of cash from the business (in other words, his capital). The business would then be sold to a company for shares and the £1.4m loan would be novated to the company as part of the consideration.

Immediately after the incorporation, Steve would then lend £1.4m to the company (using the cash he extracted above) and the company would use these funds to repay the loan that was novated to it.

The end result would be that Steve has a £1.4m director’s loan account that he can draw on tax-free.

Some commentators (and, more importantly, HMRC) suggest that this is offensive because a tax-free director’s loan has been conjured out of thin air.

Hamilton Rose's view

We wonder whether HMRC has got the wrong end of the stick here. After all, any loan account that Steve (example above) ends up having with his company is derived completely from funds which have already had tax paid on them. Intuitively, this seems unoffensive.

In a non-property scenario, it seems clear that trade debtors need to be transferred (as a non-cash business asset) to secure s162 relief. It would seem quite reasonable for the sole trader to sell these debtors to a factoring company and then withdraw the cash from the business prior to incorporation and this is arguably not much different from the bridging loan arrangement.

Having said all this, everyone should remember that bridging loans do rely on the good grace of HMRC accepting that the ESC applies. Therefore, particularly in light of the stop notice, it makes sense for taxpayers to seek assurance from HMRC that the ESC should apply in any circumstances that look slightly "different".

This assurance can be obtained through the mechanism of a non-statutory clearance. We would be interested in hearing about any experiences that readers have had with HMRC in this area!