The case considered whether three loans advanced to a company (in which the lender had a 50 percent ownership interest) and which were impaired in the same period as the advance were loan relationships. HMRC contended that the annual advances and immediate write-offs did not meet the requirements to be loan relationships; there was not a money debt or, if there was, this did not arise from the lending of money. As a result, the impairment debits would not be deductible. The First-tier Tribunal (FTT) decided that the advances did give rise to money debts and these arose from transactions for the lending of money notwithstanding the fact that there was no realistic prospect of repayment when the advances were made.
Did the advances give rise to a money debt?
- HMRC said that there was no money debt because although the advances were interest bearing, no interest has ever been paid by the borrower nor did it have the capacity or any credible plan to repay the advances. Rather, the advances were in the nature of capital contributions or equity; and
- The FTT disagreed saying that there is no requirement that interest is charged in order for there to be a loan relationship nor is there a requirement that the lender must have a degree of certainty that the debt will be repaid. Based on the evidence, there is a money debt because the advances were, in law, repayable with interest, they were recorded in the accounts as receivables and had not been formally released.
Did each money debt arise from a transaction for the lending of money?
- HMRC contended that if an advance did give rise to a money debt this did not arise from a transaction for the lending of money because at the time it was made the recipient could not have repaid it and had no plausible plan for doing so; and
- The FTT decided that the advances should not be characterised other than as loans. The advances were made to subsidise running costs in the hope of obtaining repayment of some or all of the loans, possibly with a gain on the lender’s share investment. The advances were made through arm’s length negotiation between the two parties, there was an obligation to repay (recognised in the audited accounts), and the fact that the lender might not recover some or all of its money did not change the character of the transaction.
What are the wider implications of the case?
- The loans were advanced prior to the adoption of new UK GAAP. The loans were initially recognised at the amount advanced and HMRC did not dispute that this was GAAP compliant. The accounting might be different under new GAAP depending on the standard adopted. If a loan asset is initially recognised at less than face value because the borrower is unable to repay the amounts advanced, any impairment debit would be reduced;
- HMRC do not appear to have argued that the impairment debits should be disallowed under transfer pricing rules and the FTT said that the advances were commercial. More generally if advances are within the scope of transfer pricing rules, perhaps via the extended ‘acting together’ meaning of connection, the impairment debits may not be deductible; and
- HMRC had considered whether the unallowable purposes rule would disallow the impairment debits but it seems this was dropped prior to the case being heard. There is a question as to whether advancing a loan where there is no realistic prospect of repayment is within the business or other commercial purposes of the ‘lender’. If it is not, the unallowable purposes rule may apply to disallow the impairment debit.
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