Ken Moody looks at capital loss relief for loans to traders and (as usual) finds a few ‘quirks’ to chew over in the legislation and the related HMRC guidance.
The capital gains tax (CGT) legislation in TCGA 1992, s 253 (relief for loans to traders) provides for capital gains tax (CGT) loss relief where an individual has lent money to a ‘trader’ which has been used for the purposes of the trade but where the debt has become irrecoverable. The trader could be a company or an unincorporated business but must be trading or preparing to trade.
Is it really irrecoverable?
HMRC has somewhat fixed ideas, however, as regards the meaning of ‘irrecoverable’ (see HMRC’s Capital Gains Manual at CG65930P):
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HMRC correctly argues that the legislation requires that the loan must have become irrecoverable which would not apply if the loan was irrecoverable when it was made.
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HMRC will normally resist a claim for relief if the trader continues to trade, arguing in that case that there must be some prospect of recovery.
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The loan must be completely irrecoverable (i.e., a partial claim is not admissible).
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A partial claim may, however, be made where part of a loan has been used for trade purposes and the rest for non-trade purposes.
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No relief is due where a loan has become irrecoverable due to some act or omission by the lender.
It strikes me that since HMRC argues that the loan must have become wholly irrecoverable (see 3. above), the argument put forward at 2. could be employed on behalf of the taxpayer at 1. since almost no-one would lend money to a trader if it was obvious they could never recover it.
HMRC does accept, however, that there may be circumstances where there is no reasonable prospect of recovery even though the borrower continues to trade, so their views are not wholly one-sided. As usual, it will depend upon the available evidence.
If the borrower is a company, the lender will usually be a director-shareholder and the ‘loan’ will normally consist of a single loan account in the books of the company. However, it is clear from the legislation and the HMRC guidance that monies advanced by the same lender at different times are not all lumped together as one ‘loan’.
Multiple loans
As noted, HMRC does not accept a claim that part of a loan has become irrecoverable, except where the debtor is in bankruptcy or liquidation, and the outcome is therefore predictable. However, the guidance does consider circumstances where loans made at different times may or may not have become irrecoverable. Briefly, if further loans are made after earlier loans were claimed to be irrecoverable this may indicate that the earlier loans had not become irrecoverable or that the later loans were irrecoverable when made, and so not eligible for relief.
While I would accept HMRC’s argument that a partial claim is not admissible in relation to an individual advance, it must be possible in principle to claim that there is a reasonable prospect, for example, of recovery of loans a, b, and c while the recovery of loans e, g, and f is remote (applying the ‘first-in, first-out’ rule established in what is referred to as ‘Clayton’s Case’ (Devaynes v Noble [1816] 35 ER 781 – a banking case). There would need to be a strong evidential basis for such a claim, but one can imagine such circumstances arising.
Practical tip
It is tempting to consider capitalising a doubtful debt as share capital, where the borrower is a company, and claiming income tax share loss relief. This is unlikely to work, since the CGT market value rule will apply, so if the company is in financial difficulty, the value of the shares acquired may be much less than the face value of the debt. Moreover, by doing so, this will preclude any claim for capital loss relief under TCGA 1992. s 253.
