Insolvent Balance Sheet

System
System Posts: 100,537 🤖 Admin 🤖
edited June 9 in General accounting discussion
Hi
i have acquired a new one director Ltd company with net liabilities position for 2005 & 2006 accounts.

I have drafted the 2007 and it is a loss for the year £5,151, this accumulates the negative balance sheet position at £7,350.

The directors loan account is in credit £8,197.

Can anyone please advise what the implications can be of submitting accounts with continous net liabilities?
many thanks.

Comments

  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    Unless your client wants to obtain a loan any time soon then it is not really a problem at all.

    Many fledgling companies will be insolvent with many of the costs being paid by the owners personally to be reimbursed when the company is profitable.

    You should make sure there is a going concern note in the accounts. Here is a cut and paste of the one we use:

    The board considers that, notwithstanding the Company's negative net assets position, it is appropriate to prepare the accounts on a going concern basis as the company will be able to continue to meet its liabilities as they fall due, due to the continuing support of the board.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    thankyou kindly for your advise.

    i feel :D that it is not all bad as far as i know the client does not intend to obtain loans in the near future.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    There are other issues here. The fact that the directors have loan accounts might tempt them to draw down on the loan and this could place them in a very difficult position if the company is subsequently placed into liquidation. The directors should not repay their loans as this would be viewed as preference.

    Have you considered increasing the share capital by converting the directors loans into fresh capital? This might reverse the insolvent position?

    If the directors cannot withdraw funds anyway they would not be any worse off by taking additional shares. If the company does fail at a later date the personal tax position of the directors is better in respect of the loss they have suffered.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    I wouldn't recommend issuing shares.

    We do not have all the details but this sounds like a small one-man-band company. It seems unlikely to be going into forced liquidation any time soon, particularly as it seems the only sizeable creditor here is the owner/director.

    Drawing down a loan account in future is a way of extracting funds with no tax implications. Issue shares and you could kiss goodbye to seeing that money again. Furthermore, the relief available if the business subsequently fails is pretty minimal; particularly if the shares are of negligible value when subscribed for, which would certainly be the case in an insolvent company.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    I would tend to agree here with Dean because if it is a new company then (more often than not) they are expected to make losses in the first couple of years whilst they become established. Certainly working capital in the first couple of years is often funded either by the owner or business start up loans, or both, when they first start trading.

    Smaller companies tend not to increase their share capital in these circumstances, the directors tend to redeem their loan accounts in full, or in part, when (a) profitability allows and (b) when cash flow allows.

    Steve
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet
    deanshepherd wrote:

    Drawing down a loan account in future is a way of extracting funds with no tax implications. Issue shares and you could kiss goodbye to seeing that money again. Furthermore, the relief available if the business subsequently fails is pretty minimal; particularly if the shares are of negligible value when subscribed for, which would certainly be the case in an insolvent company.

    I agree that future draw down of loan has no tax implications but the chances are that in this company the shareholders are not higher rate tax payers and so could equally extract future profit by way of dividend without any real tax implication. Whilst the balance sheet is insolvent they would be well advised not to draw down on loans in any event and therefore would possibly ( depending on circumstances) not be any worse off by issuing shares and looking to dividends in future rather than withdrawing loan.

    This could solve the insolvent balance sheet in the interim and present a better personal tax position if the company were to fail later.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    My thoughts..

    I think it is a bit of an assumption that they will never be higher rate taxpayers. Once the company is profitable there is nothing to stop them declaring dividends until they are higher rate taxpayers and then drawing down their loan.

    Also given that they appear to be the only or main creditor with little money in the bank, drawing down the loan is not really an option; ill-advised or otherwise.

    The director has obviously plugged a lot of money into his own company, issuing shares means he will never see that money again.

    With an owner/director close company the only time a negative balance sheet is a problem is when accounts are being relied upon by external stakeholders. Does he have unsecured bank loans? Does he need the accounts for a mortgage? In both cases, regardless of tidying up the balance sheet, the P&L is going to send alarm bells ringing.

    I just cannot see the advantage of issuing shares. Even if this creates a capital loss in the future, does he have any gains to utilise it? Unlikely I would have thought.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet
    deanshepherd wrote:
    My thoughts..

    I think it is a bit of an assumption that they will never be higher rate taxpayers. Once the company is profitable there is nothing to stop them declaring dividends until they are higher rate taxpayers and then drawing down their loan.

    Also given that they appear to be the only or main creditor with little money in the bank, drawing down the loan is not really an option; ill-advised or otherwise.

    The director has obviously plugged a lot of money into his own company, issuing shares means he will never see that money again.

    With an owner/director close company the only time a negative balance sheet is a problem is when accounts are being relied upon by external stakeholders. Does he have unsecured bank loans? Does he need the accounts for a mortgage? In both cases, regardless of tidying up the balance sheet, the P&L is going to send alarm bells ringing.

    I just cannot see the advantage of issuing shares. Even if this creates a capital loss in the future, does he have any gains to utilise it? Unlikely I would have thought.

    Hi

    I didn't actually suggest that the shareholders would "never" be higher rate taxpayers - only that they were unlikely to be so at present and so dividends would be as tax neutral as loan drawdown.

    With regard to the balance sheet - issuing shares would improve the net assets/liabilities position and this is a prime factor for credit agencies such as Dunn & Bradstreet etc. Therefore an improved balance sheet might assist with opening trade accounts as the company might have a more favourable credit score.

    Finally, and this was the real issue, if the company were to fail in its current state, the director would have lost his loan. His option is to make a claim under S.253 TCGA 1992 for this to be treated as a capital loss but as you rightly infer - he will probably have no gains to offset this loss.

    BUT

    if the share issue had taken place his loss will relate to shares in a trading company and the capital loss can be offset against all income of the same or preceding year not just Capital Gains.
    See S.574 ICTA 1988 and S.24 TCGA 1992

    If the company is struggling then surely its worth discussing this option with the client?
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Insolvent Balance Sheet

    Just to note: S.131 ITA 2007 has replaced S.574 ICTA although the rules are near enough the same.

    However, no relief is available under S.24 TCGA if the shares are of negligible value when subscribed.

    Shares in an insolvent company will always be deemed to be of negligible value. You would not be able to make a claim under S.24 TCGA.

    If a Dunn & Bradstreet credit score is more important than getting £8,197 of investment in the company back then I guess it is an option.

    Also, we should bear in mind that we do not know a great deal about the trading history or future plans for this company. As Steve said, many new companies will make opening year losses funded by the directors. I don't think we should assume the company is failing and on the point of winding up.

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