Never a Lender nor a Borrower Be - Unless it is Tax-Efficient
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Every business will have to look carefully at cash flow management throughout
its business life, dealing with “Cash Mountains,” controlling distributions and
commercial borrowings. Each individual sole trader, partner, shareholder or
investor has to look at their own tax position and this includes inheritance tax
The focus of the business has to be commerciality, however a recent case
“Philips”, has shown the need to ensure that all loans are ideally inheritance
tax (IHT) efficient for Business Property Relief (BPR), whilst also achieving
maximum corporation and income tax relief. Can this present a conflict of
The Special Commissioners’ case of Executors of Rhoda Phillips v HMRC 
At the date of her death in June 2001, Ms Phillips owned 245,000 PPI shares,
but HMRC determined that her shares did not qualify for BPR. Ms Phillips’
executors appealed and the Special Commissioner was called on to determine
whether the business of PPI consisted ‘wholly or mainly of … making or holding
investments’ per IHTA 1984, s 105(3).
Ms Phillips was a widow and she held a majority shareholding in the company
(PP Investments) which lent money to related family companies. Her executors
claimed BPR. HMRC rejected the claim on the basis that the PPI business
consisted mainly of making or holding investments within IHTA 1984, s 105(3).
The case emphasised that for BPR purposes, it is important to look at the
activity of the business at date of death and two years before and not the
activity undertaken by the business in the past. Thus, the fact that until 1989
the company had been a property investment business was not relevant to the
current claim for BPR.
The business of making loans
The ultimate finding of this case was that the activity of money lending is a
trading activity. The commissioner allowed the executor’s appeal, finding that
PPI was a banking arm for in-house transactions and holding that they did not
regard the activities of a money-lender as investment. On the evidence, PPI was
in the business of making loans and not in the business of investing in loans.
The loans were not investments for their own sake but the provision of a finance
facility to the other companies. Accordingly the shares in PPI qualified for
The commissioner determined that the business here was not one of investment
(s 105(3)) because she did not believe that making loans necessarily equated to
an investment activity – and therefore the relief was due.
Dead bed loan planning
The allocation of secured borrowings is essential planning to protect against
the potential IHT liability that might arise if the borrowings are not allocated
correctly. When reviewing the potential IHT liability of property and the
related borrowings at the date of death, there is no requirement for a liability
to have been secured on a particular asset for any particular length of time.
The appropriate arrangement of borrowings can lead to “deathbed” tax planning,
though of course any rearrangement of borrowings must be completed prior to the
date of death.
“Wholly and exclusively” linking with security
The aim of every business is to achieve maximum tax relief on borrowing.
Income and corporation tax relief is given for interest paid on borrowings
incurred ‘wholly and exclusively’ for the purpose of a trade. Similar rules
apply for borrowings to finance a rental business. This tax relief on interest
payments is therefore given according to the purpose of the loan whereas for IHT
purposes, a loan is matched with the assets on which it is secured or charged.
An anomaly of the different taxes is that the loan can be for the purpose of
purchasing one asset and it can be secured against a totally separate asset. It
is often beneficial for IHT purposes to secure a loan on assets which do not
qualify for any IHT reliefs rather than business assets. Thus the value of the
business assets is increased and therefore so is the BPR claim whilst the IHT
vulnerable assets are reduced by the borrowings. The tax planner must consider
whether a conflict of interest arises in trying to juggle income tax,
corporation tax and IHT relief. Who is the client? Who is seeking advice? Who
is giving the instruction? Sole traders do not present such a problem but
companies and partnerships can require either disclosure of the potential
conflict or alternative independent advice being sought.
Loan planning in advance of the deathbed
Deathbed loan planning certainly has a part to play in IHT planning, but
clearly long-term restructuring and possible refinancing should be put in place
at an early stage to ensure maximum tax reliefs are achieved. For example it
might be that corporation or income tax relief is available on loan interest
where tax relief might not have been previously allowed or might have been
disallowed due to not being wholly and exclusively for the purpose of the
trade. In an ideal world all clients should undergo a “loan management” tax
review or audit.
Re-allocating borrowings APR v BPR
Review of the tax efficiency of loans which would result in the reallocation
of borrowings should not give rise to CGT problems. There are important
differences between APR and BPR in the context of borrowings. Under IHTA 1984,
s 110, for the purposes of BPR the value of a business or an interest in a
business is to be taken as the net value i.e. the value of the assets used in
the business reduced by the aggregate amount of liabilities incurred for the
purposes of the business, regardless of the security given.
APR is restricted to “agricultural property” and loans secured on that
agricultural property. “Agricultural property”, as defined by IHTA 1984, s
115(2) means agricultural land or pasture and also includes such cottages, farm
buildings and farmhouses, together with the land occupied with them, as are of a
character appropriate to the property.
When looking at reallocating borrowings it is also imperative to review
excess cash balances (the “cash mountain”). The potential future claim for BPR
or APR must therefore be assessed when looking at the borrowings structure to
ensure maximum benefit is achieved.
The IHT requirement for the “cash mountain”
It is equally important to ensure that any excess cash deposits are protected
by an IHT claim. It has to be shown to be for future use. The Barclays Bank
Trust Company Limited verses IRP (1998) SSCD 125 (SPC C158) highlights this.
The question was whether £300,000 “cash mountain” held by a company was an
excepted asset under IHTA 1984, s112 (2) and therefore did not qualify for IHT
relief. The facts were that the deceased died in November 1990, holding 50% of
the shares in a company, her husband held the other 50%. The company sold
bathroom and kitchen fittings, mainly to the trade. The cash position was
strong. The company did not tie up working capital either in premises (which
were occupied rent free and which belonged to the deceased) or in stock. The
company’s cash at bank and in hand in 1990 was over £450,000. Cash was invested
for periods of up to 30 days. Turnover was around £600,000.
In February 1990 the company approached a similar company and expressed an
interest in buying the properties of that company. The other company did not
reply and was later liquidated. In 1997 the company spent over £355,000 on a
venture in the purchase of goods imported from China.
HMRC accepted that the company needed £150,000 in cash at the death of the
deceased, but since issued a Notice determining that £300,000 was not so
required. The appellant, executors of the deceased, appealed.
The decision was that on the evidence of the facts presented, the £300,000
was not required for the purposes of the business. An asset did not cease to be
an excepted asset because at the time of the deceased’s death it might be
required at any time in the future. “Required” in IHTA 1984, s 112(2)(b) did
not include the possibility that the money might be required should an
opportunity arise to make use of the money in two, three or seven years time for
the purposes of the business. Some imperative was implied that the money would
fall to be used on a given project or for some palpable business purpose. There
was no evidence on the facts that the company was to be the purchaser of the
assets of the other company. The money was not “required”. The appeal was
The message to the tax planner is that for IHT relief to be achieved cash
surpluses must be required for future use AND there must be evidence to support
this. If there is no argument to support for future use then an alternative
should be considered.
Alternative uses for the cash mountain
What are the alternatives? For example to repay family, or group borrowings
if appropriate, loan planning must also incorporate a review of cash balances to
see where repayment can be achieved and improve potential IHT relief for the
owners of the business. Cash Mountains could be taken from the incorporated
business and invested in “IHT efficient investment products” to prevent them
being caught under s 112.
There are schemes available which effectively allow the donor some measure of
income stream without apparently contravening pre-owned assets or gifts with
reservation of benefit legislation.
Repaying, borrowing or even achieving IHT relief as a money lender as in the
Phillips case appears more capable of achieving the risk management tests. It
is essential that written confirmation as to the availability of IHT relief is
obtained and ideally a copy of the supporting Tax Counsel’s opinion.
Loans to traders – The HMRC “cat”
Loan to traders that are not repaid can achieve Capital Gains Tax (CGT)
relief. When organising loan management, it is also essential to understand the
ability to claim this CGT relief under TCGA 1992, s 253. The tax case of Daniel
Conrad Crosby and others verses Broadhunt (SpC 416 19.5.04) showed that the
claim does not have to be made at the point the loan is waived and released.
The facts were H Ltd was a trading company that had been lent money on two
occasions by the trustees of a settlement made by E. By 1991, it had total
debts of over £2 million, including the aggregate £250,000 owed to the
settlement. The Revenue accepted that the loans were then irrecoverable. The
shareholders were able to secure a sale of the company to its then managing
director and an outsider, neither of whom was a member of the settler’s family.
The sale was completed in March 1992. One condition of the sale was that the
trustees should execute a deed of waiver and release of the loans, and this was
done. However, H Ltd continued to decline and it entered in to receivership in
The settlement’s 1992-93 tax return included a claim for a capital loss of
£250,000. The inspector refused the claim, based upon the view that, at the
time of a claim for relief, the loan must remain in existence i.e. it must not
have at this point be written off, waived or released; the trustees appealed.
The taxpayers’ argument was based on the purpose of the legislation, which
related only to a limited class of loan, i.e. those made to traders. It could
be deducted that it was intended to encourage such loans by allowing the lender
relief if the borrower became unable to repay the loan. The Revenue’s
interpretation of TCGA 1992, s 253(3) that the loan must still be in existence
at the time the claim is made, was unwarranted. It was clear in this case that
at the time the claim was made the loans had become irrecoverable and the waiver
did not affect that position. It did not cause the irrecoverability, nor would
the loans have become recoverable again had there been no waiver.
The Revenue’s opinion was that the statutory words were clear. The use of
the words ‘has become irrecoverable’ necessarily implied a continuing state of
affairs. They gave as an analogy the sentence ‘my cat has become ill’: one
would not use that form of words if the cat had since recovered or died, but
only if the cat were alive and still unwell.
What did the Commissioners decide?
The commissioners returned to the Revenue’s cat. While it is right that one
would not say ‘my cat has become ill’ one might say ‘my cat has become ill and
has recovered several times’. The latter sentence implies no continuing state
of affairs. The semantic subtlety on which the Revenue’s argument depended had
to be treated with some caution.
The commissioners agreed instead with a point made by the taxpayer that if
parliament had intended that a loan must be both subsisting and irrecoverable it
would have been simple to say so. The appeal was allowed.
It is hoped that with the merger of the Revenue and Customs, the HMRC “cat”
is still alive and well …
The tax planning key is to review all loans to traders that might not be
recovered and ensure maximum CGT relief is obtained if appropriate.
Professional logistics of financial planning
There are a number of logistical problems surrounding tax planning, planning
around the subject of borrowings, money lending and Cash Mountains in the form
of the Financial Services Act.
Firstly, many small businesses do consider it appropriate to involve their
tax adviser in the borrowing arrangement and sadly seek tax advice in a
retrospective manner. Secondly, the advice can be defined (or considered to be
defined) as the provision of financial services and some firms are concerned
over the understanding of their professional code of conduct and the problems
this might create. Thirdly, at large firm level the corporate finance
departments are totally dedicated to corporate efficiency but not so aware of
for example the IHT considerations. There could also be a conflict of interest
between the corporate tax planning advice where the client giving the
instructions is the company and the shareholder (who needs the IHT advice) is a
conflicting client interest. Likewise in a partnership where the tax adviser is
appointed and instructed by the partnership to advice on income tax efficiency
of loans has to consider the IHT position of the individual partners. If there
are conflicting the IHT requirements the tax planner must identify the conflict
or suggest alternative independent advice.
Restriction of Investment advice
There is a new code of ethics issued by ICAEW which identifies just who
accountants (and tax advisers bound to this code of ethic) can refer their
Members of the ICAEW have a completely new professional code of ethics from
September 2006 which now takes in to account changes in the provision of
financial services advice and the introduction of the Insurance Mediation
Directive. The updated code, which is available on the ICAEW website,
highlights the need for members to fully understand the nature of the referral
they are making and whether or not their authorization means they can actively
make a referral or whether they are restricted to a more passive referral style
by providing information only.
Section 241, Agencies and Referrals, highlights that referrals should only be
made where the status of the investment adviser is compatible with the
overarching requirement ‘to give objective advice’. The tax planning work
regarding business cash flows can move over to the domain of investment advice
and complime with the appropriate code of ethics is essential.
So many angles of financial planning for the business are carried out in
aspect based on an immediate need of the requirement i.e. asset needed now
obtain instant borrowings. The cash flow tax audit is an essential way forward
subject to restrictions set out above.
About the Author
Butler & Co specialise in the
farming and equine industries, focusing on preparation of accurate, detailed
accounts combined with expert tax advice and planning, particularly in the
fields of Inheritance Tax and Capital Gains Tax.
Julie Butler FCA can be contacted by Tel: 01962 735544 or Email;
Butler & Co.
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Article Published/Sorted/Amended on Scopulus 2007-05-20 22:06:22 in Tax Articles