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A bakery business seeking to expand into new premises raised finance to pay for the move by offering ‘bread bond loan stock’ to customers. Loan stock is issued in units of £2,000 for either a three, four, or five-year term.
The terms of the loan stock, so far as are relevant, state:
- repayment of loan stock is due in full on ... (date);
- interest equivalent of 6%; and
- interest is paid to the holder as a loaf of bread (average retail value £2.50) of the customer’s choice (48 weeks a year) baked on a Tuesday or a Thursday and collectable from the bakery.
The 1948 case of Gold Coast Selection Trust Ltd v Humphrey [1948] 30 TC 209 established that where a trader is paid in kind he can be assessed on the second-hand value of what he receives, if what he receives is marketable in nature.
Does the same principle apply to the interest paid on the loan stock here, and if not why not?
If it does, would readers agree that a second-hand loaf is not marketable and there is no value to be taxed?
Query 17,975 – Crusty
Reply from Maninblack
Crusty has made a common error when considering a barter transaction: he is looking at it from the wrong point of view. The loaf is received by the customer as consideration for the loan of money.
The customers are presumably private individuals who are not receiving the bread in the course of any business, so the Gold Coast case is not applicable to them.
Their tax question is whether the bread represents taxable interest income which should be declared on their tax returns.
In my view, as a clear monetary value is placed on the annual interest at the start, this is taxable income: the fact that it is paid in kind makes no difference. Someone receiving £120-worth of bread for holding £2,000 of loan stock must pay tax on it.
The trader is supplying bread and receiving consideration in the form of a loan. VAT cases suggest the answer for the income tax profits, although they are not directly applicable as the bread will be zero-rated.
There is a clear agreement between the parties as to the value of the barter element (as in the case of Westmorland Motorway Services [1998] STC 431).
The trader is therefore selling £120-worth of bread for £120 – the full selling price. To put it another way, they have agreed that the interest is £120; the customer has accepted bread to that value in place of money and that should make no difference to the tax treatment.
However, from the trader’s point of view it should also make no difference to profit, as there will be a deduction and a receipt of the same amount.
The most ‘interesting’ question is whether the trader has an obligation to deduct tax from the interest, and how that could be achieved if so.
It would be amusing to send 20% of each loaf to HMRC once a quarter, but sadly it would have to be done in money.
HMRC’s Savings and Investment Manual (at SAIM9070) explains that tax has to be deducted from ‘annual interest’ paid by a company to an individual. The three to five-year loans at a fixed rate appear to satisfy all the conditions.
Given that the customer will receive 6% ‘gross’ in the value of the bread, it seems that the company (if the baker is one) should account for 20% of a grossed-up 7.5% rate. The customers would then receive a tax credit at the basic rate on their bread.
It’s a shame that such a brilliant idea should be so complicated.
Reply from Kitt and Kiln Girl
There are clearly two issues wrapped up within Crusty’s conundrum: the value of the loaves in the hands of the bond holder; and the value of the goods ‘sold’ as payment or settlement of the interest by the bakery owner.
It is assumed that the bakery business in question is an unincorporated concern and outside of the loan relationship regulations, which would require the recognition of the said loaves as a ‘money debt’.
In these unincorporated circumstances, the key concern for the bakery is the enduring Sharkey v Wernher principle, often ascribed to the appropriation from stock.
This case was often rolled out (sorry!) by tax inspectors, prior to its legislative footing, to capture the cost of goods or services in kind, particularly for property developers and service industry providers, such as restaurateurs (free meals) and publicans (free drinks).
Just to recap, Sharkey v Wernher was the tax case where it was decided that a trader, who appropriated equine breeding stock from her business for private purposes, should account, for tax purposes, for the profit that would have arisen had the stock been sold in the normal course of business.
The decision went on to spawn an industry of adjustments by keen tax inspectors in all but the most meager of circumstances.
The standard exceptions to Sharkey were ‘tradition’ and ‘insignificance’. These exceptions were codified in the HMRC ESC A19, before the whole issue was put into legislation in 2008.
To put the Sharkey principle into an appropriate context, and give this contentious decision a statutory footing, the principle of taxing appropriated goods or services at their market value, was enshrined in legislation under ITTOIA 2005, s 172A–F for income tax and FA 2008, Sch 15 Part 2 for corporation tax.
These codes apply in the circumstances below, unless the transfer pricing legislation applies in which case that would have preference.
This legislation goes on to state that the Sharkey principle applies where either goods are taken for:
- private use; or
- long-term investment
Given the structure of the bond facility as a long-term investment, it would seem that the issue is relevant if material, and the key to its resolution is the appropriate valuation of the loaves.
As Crusty correctly observes, the value of a £1 loaf at the end of the day may properly be 10p, would HMRC therefore stand good the ‘loss’ of 50p, were the loaves to have cost 60p to produce?
Or would this encapsulate the ‘unfairness’ of Sharkey v Wernher 36 TC 275 by seeking to tax unrealised illusory profits, particularly when a surplus is wasted or unsold at the end of the business day?
The ‘receipt’ in the warmed hands of the lender should hopefully be of negligible or marginal value and never steer into the Gold Crest parameters.
This is because the facts of the Gold Coast case concerned valuable assets or goods other than cash received in the course of a trade. In Gold Coast, this was shares which were allotted by G as consideration for the sale of a mining concession. The case is therefore not on a ‘parallel’ with Crusty.
As Viscount Simon highlighted in Gold Coast:
‘If the asset is difficult to value, but is nonetheless of a money value, the best valuation possible must be made, and cannot be an exact science’.
Presumably aging loaves would have had no more value in 1948 when Gold Coast was decided than in 2012.
