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A Brief Opportunity
ANDREW GOTCH highlights a mismatch in the loan relationship provisions.
COMPANY A HAS a 50 per cent interest in company B. Company A has made funding loans to company B in the past and these are irrecoverable. Company A accounts to 30 September; company B accounts to 31 March. Both companies are close. If company A releases the loan, what are the tax consequences?
A Brief Opportunity
ANDREW GOTCH highlights a mismatch in the loan relationship provisions.
COMPANY A HAS a 50 per cent interest in company B. Company A has made funding loans to company B in the past and these are irrecoverable. Company A accounts to 30 September; company B accounts to 31 March. Both companies are close. If company A releases the loan, what are the tax consequences?
It seems that swift action can give a beneficial tax analysis for both parties. For accounting periods commencing after 30 September 2002, the connection rules in section 87, Finance Act 1996 have changed. Company A does not control company B (section 87A, Finance Act 1996) and so is unconnected with company B from 1 October 2002. Company A gets a deduction for the amount released; what about company B? The new connection rules do not apply to it yet and so the old rules apply, under which a connection exists if the company is a close company and the other person is a participator in that company. Company A is a participator in company B and so company B is connected with company A. Thus company B does not have to bring in an amount in respect of the release - but only if the release takes place during company B's current accounting period. On 1 April 2003 the companies cease to be connected and so company B will be taxed on a subsequent release, although company A will continue to get a deduction.
So there is a deduction for a bad debt with no corresponding tax charge. Is this too good to be true?
Paragraph 6C of Schedule 9 to the Finance Act 1996 makes provision for certain tax treatments for loan relationship creditors if a connection ceases. Does it apply here to company A's deduction in its current accounting period? By paragraph 6C(1)(a), the paragraph applies:
'Where, in the case of a creditor relationship of a company, a departure that would otherwise have been allowed under paragraph 5(1) above in respect of an amount is or was, by virtue of paragraph 6 above, not allowed in the case of an accounting period …'
Paragraph 6 of Schedule 9 denies a deduction for a bad debt when there is a connection between the parties. However, it operates only where a departure is allowed by paragraph 5 of Schedule 9 from the assumption in section 85(3)(c), Finance Act 1996 that every amount due under a loan relationship will be paid in full as it becomes due. That assumption is one that falls to be made when ascertaining the amount to be brought into account for an accounting period in accordance with section 84(1), Finance Act 1996, which says, so far as relevant:
'The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question all profits, gains and losses of the company, including those of a capital nature, which (disregarding interest and any charges or expenses) arise to the company from its loan relationships and related transactions …'
In other words, if an amount is not brought into account for an accounting period, paragraph 6 does not - and cannot - come into play in respect of it. It follows that paragraph 6C cannot apply if a sum that is brought into account has not been brought into account and been the subject of a paragraph 6 restriction in an earlier period during which the parties were connected under the old rules. The verbs used are 'is' or 'was', and not 'would have been', and they take their natural meaning.
The legislative intention
Is that interpretation consistent with the meaning of paragraph 6C? The restriction on deduction that paragraph 6C(3) imposes is this:
'Where this subparagraph applies, no debit shall be brought into account in respect of an amount for the first accounting period [after the connection ceases], or for any subsequent such accounting period, to the extent that the amount in question represents the amount mentioned in subparagraph (1)(a) above'.
It seems that it is entirely consistent. Paragraph 6C(3) applies to, for example, interest payments due under a loan relationship which would have been taxed on the creditor in the past because of paragraph 6(3), even though there may have been no prospect of payment taking place; the deduction for the bad debt which might now otherwise be possible in the post-connection period is stopped. Consistency for the past is maintained.
That interpretation is internally consistent also with paragraph 6C(2), which prevents the recovery of a debt for which no deduction was allowed under the old rules from being taxed again on the creditor in the post-connection period, as it would otherwise fall to be. Once again, consistency with the past is maintained.
Finally, although second-guessing the intention of the legislature is a primrose path, there is also a clear 'policy' reason to believe that this is a correct interpretation. If paragraph 6C served to deny such a deduction for the writing-off of a debt in an accounting period after a connection had ceased, a debtor would always be taxed on a release after the connection ceased, but there would never be a deduction for the creditor.
Notwithstanding that the interpretation suggested in this article gives a clear advantage to certain taxpayer companies in a diminishing window of opportunity, the punitive and perpetual lack of symmetry flowing from the alternative interpretation would be highly unusual.
Andrew Gotch is a consultant with the Professional Tax Practice Ltd, e-mail: andrewgotch@ptpgroup.co.uk.
