Whether their owners realise it or not, companies large and small are affected by the loan relationship rules. The legislation is extensive and complex – over 400 sections (across CTA 2009, Pts 5-7). The rules apply to certain types of securities, financial arrangements and instruments – too many to mention - as well as to more mundane loans and other debts.
Most of the loan relationship (LR) rules relevant to this article are found in CTA 2009, Pt 5.
Only companies have loan relationships. A company may have a loan relationship with an individual (e.g. if the company lends money to a director, or vice versa), but the rules have no relevance to the director.
A company has a loan relationship if it stands in the position of debtor or creditor as respects a ‘money debt’, and the debt arises from ‘a transaction for the lending of money’. ‘Money debt’ is, broadly, self-explanatory, but not every money debt arises from a transaction for the lending of money. A loan to a company from a bank is clearly both. But (for example) an overdrawn director’s loan account is a money debt, which does not necessarily arise from a transaction for the lending of money. Similarly, intercompany loan accounts between group companies may or may not arise from transactions for the lending of money.
However, certain ‘relevant non-lending relationships’ are brought within the LR rules (by CTA 2009, Pt 6, Ch 2), as regards ‘relevant matters’. Significantly, for the purposes of this article, a trade debt is brought within the LR rules under Chapter 2 (s 479).
The debits and credits to be brought into account in respect of a company’s loan relationships are, broadly, those recognised under generally accepted accounting practice.
Trading and non-trading debits and credits
It is necessary to distinguish between trading and non-trading LRs. A trading loan relationship is one entered into for the purposes of a trade carried on by the company, and debits and credits in respect of the loan are treated, respectively, as trading expenses or receipts. Where a company borrows money, which it uses for the purpose of its trade, relief for interest payable is given as a trading expense, and therefore no adjustment is normally required for corporation tax purposes. However, where a company stands as creditor in respect of a LR, credits are treated as trade receipts only if the company is party to the LR in the course of activities forming an integral part of its trade. This will normally apply only to banks and other lending institutions.
Otherwise, interest received is a non-trading credit (e.g. interest on a company bank deposit account), which is ‘added-back’ in arriving at the company’s trading profit and brought in as a non-trading profit, though the overall effect is usually neutral. A non-trading debit, on the other hand, may not be neutral. If a company’s non-trading credits (interest received, etc.) exceed its non-trading debits, the excess is, again, taxable as a non-trading profit. However, an excess of non-trading debits over non-trading credits is a non-trading loan relationship deficit (NRLRD), which can only be:
a) offset against total profits of the same period;
b) carried back against total profits of the previous period;
c) carried forward and offset against future non-trading profits; or
d) surrendered as group relief.
Special rules apply to debt between companies that are connected. Companies are connected if one controls the other, or both are under the control of the same person. The legislation refers to ‘person’ in the singular, though the decision in Floor v Davis  STC 379 appears relevant. A similar reference to ‘person’ in TCGA 1992, s 29(2) relating to value-shifting, was deemed to include the plural.
Impairment of debt between connected companies is broadly neutral under LR rules. On the one hand, the creditor company gets no relief for any write-off (CTA 2009, s 354), and the debtor company is not taxable on any credit to its profit and loss account in respect of any release (s 358). So, if Company A lends money to connected Company B and Company B becomes insolvent and is wound up, Company A will get no relief for the write-off of the debt.
The ‘unallowable purpose’ test
A similar situation may arise, but for a different reason, where companies are owned within a family but are not connected (e.g. where Mr X owns 100% of the shares in Company A and his son Mr Y owns 100% of Company B). The connected companies test for LR purposes does not involve any attribution of rights of associates, as it does for the purposes of the close companies’ legislation.
However, any impairment of a debt owed by Company B to Company A may not be allowable to Company A because of the ‘unallowable purpose’ test. An unallowable purpose is a purpose that is not amongst the business or commercial purposes of the (creditor) company. The debt is more likely to be as a result of the family relationship (i.e. father wishing to assist son’s business, rather than for the business or commercial purposes of company A), and therefore relief may be denied.
However, that may not always be the case. A situation on which I advised recently concerned a similar situation, i.e. father owned Company A and son owned Company B, but Company A did subcontract work for Company B. Unfortunately, Company B did not get paid for a major project and Company A had done a substantial amount of work for Company B and a debt of £300,000 had built up. Both companies ceased to trade and Company B is now dissolved. The question arose whether Company A could claim terminal loss relief for the loss which arose as result of the write-off of the debt. This in turn depended on whether the impairment was a trading expense or gave rise to a NTLRD for which relief is more restrictive as explained above. The debt was for work done, and so represented a trade debt. While there may be arguments to the contrary, I took the view that the debt was entered into for the purposes of the trade of Company A, and the debit for the impairment should therefore be treated as a trade expense, enabling a terminal loss relief claim to be made.
A welcome relaxation
Where the companies are unconnected, no credit is required to be brought into account by a debtor company if a debt is released and the debtor is insolvent, i.e. in liquidation or administration (CTA 2009, s 322). This may, however, be academic since the debtor would probably not have the money to pay the corporation tax if the credit was taxable anyway. Legislation (in s 323A, which was introduced by F(No2)A 2015) extends the circumstances where no credit needs to be brought in, where:
- a debtor relationship is modified or replaced by another;
- immediately before such modification or replacement it is reasonable to assume that, without the modification or replacement, there would be a material risk that at some time within the next 12 months the company would be unable to pay its debts; and
- the modification or replacement is treated as a substantial modification for accounting purposes.
For example, if a company owes a debt to a bank, the company is in financial difficulty and the bank agrees to write-off part of the debt, the credit to the profit and loss account in respect of the release may not now be taxable. This is helpful, of course, since if the company was taxable on the amount released this would be counterproductive.
While lending institutions do not agree to release a debt or part of a debt except where necessary, for the purposes of s 323A it is helpful to obtain as evidence an opinion or report from an insolvency practitioner to the effect that the criteria at 2. above are met.
This article was first printed in Business Tax Insider in March 2017.