Loan relationships - common problems demystified

The loan relationship rules are complex and deal with the taxation of loans between a company and another party (whether a company or not).

The loan relationship legislation was originally introduced by Finance Act 1996 and then amended by subsequent Finance Acts, before being consolidated as part of the tax law rewrite into Corporation Tax Act 2009.

The loan relationship legislation has historically been fairly opaque and confusing, and caters for many situations that most practitioners will never encounter in practice.

The key definition of a loan relationship is that it:

• is a money debt and
• arises from a transaction for the lending of money.

Both elements have to be present for the arrangement to be a loan relationship.

All profits or losses (including exchange gains and losses) arising from loan relationships are taxed or relieved as income, as follows:

• where the loan relationship arises in the course of a company’s trade, in the computation of trading income or
• otherwise as non-trading credits or debits.

HMRC defines trading and non-trading loan relationships in its manuals at CFM32020, as follows:

Debtor relationships

A company will have a trading loan relationship, as a borrower, if it entered into the loan relationship because of its trade.

So, for example, a loan taken out to purchase machinery for a manufacturing trade, or to finance an expansion of its trade, will be a trading loan relationship.

Creditor relationships

However, a company will only have trading loan relationships as a lender if it is party to a creditor relationship in the course of activities ‘forming an integral part of the trade’ (CTA09/S298).

This will usually only apply to companies such as banks, insurers and financial traders.

For each accounting period, a calculation is made of the:

(a) credits from loan relationships
(b) debits from those sources.

If (a) exceeds (b), the excess is a loan relationship credit and charged to corporation tax. If (b) exceeds (a), the excess is called a loan relationship deficit and will be available to relieve against other profits. The precise tax treatment depends on whether it is a trade or non-trade loan relationship.

The debits and credits that are to be brought into account for the purposes of the loan relationships legislation are the debits and credits arising on each of a company's loan relationships for the accounting period.

This includes all of the following:  

• all profits and losses of the company which arise from the company's loan relationships and related transactions
• all interest under the company's loan relationships
  
• all expenses (see below) incurred for the purposes of the company's loan relationships and related transactions
  
• exchange gains and losses arising to the company from its loan relationships.

Example

Olympia Ltd has a year end of 31 December. During the year ended 31 December 2013, it had the following loan relationship transactions:

• interest credit from bank deposit account: £5,000
  
• the company had a bank loan of £80,000. In 2013, the company’s bank wrote to the company and instigated an early repayment agreement of £60,000 to fully settle the loan by 31 December 2013. The company accepted this offer and settled the loan on this basis, and
  
• the company incurred legal fees of £1,000 in connection with the above bank loan settlement.

What would be the company’s non-trading loan relationship deficit for the year ended 31 December 2013?

Credits:
Interest received                                              £5,000
Loan written off by bank                                 £20,000
                                                                       £25,000
Less: Debits:
Legal fees incurred re loan write-off               -£1,000

Net loan relationship credit                            £24,000

Trading loan relationship credits or debits are taxed or relieved as part of the company’s computation of taxable trading income.

Any excess debit is relieved in the same way as a trading loss in one of the following ways:

• used in the current year and set against total profits including capital gains
• carried back against prior-year profits including capital gains
• used against future profits of the same trade
• surrendered as a group relief claim.

Non-trading loan relationship credits are chargeable to corporation tax at the applicable rate.

If the situation arises where there is an overall debit, rather than a credit, then the non-trading loan relationship debit may be relieved for tax purposes in the following ways:

• in the current year and set against total profits including capital gains
• carried back against non-trading loan relationship credits
• used against future non-trading including capital gains
• surrendered as a group relief claim.

The legislative reference for the treatment of non-trading loan relationship deficits is: CTA 2009 ss457-458.

Claims to relieve a loan relationship debit must be made within two years from the end of the period of account, unless the debit is being carried forward. 

Where a company is not connected with the other party to the loan relationship for the purposes of CTA 2009, it is able to claim relief for any impairment losses or losses arising from the release of all or part of the debtor company's obligations under a loan relationship. 

A credit does not, however, need to be brought into account when the release is part of a statutory insolvency agreement.

The situation, however, becomes more complicated where the parties are connected.

The general rule is that where the debtor and creditor in a loan relationship are connected in any part of an accounting period and the whole or part of a loan is written off, then this is effectively a ‘tax nothing’, ie the creditor company cannot claim relief for the amount of the loan written off and the debtor company does not incur a taxable loan relationship credit.

There is, however, an exception to the above when the creditor company is in insolvent liquidation; a creditor company may claim an impairment loss in these circumstances.

If an individual makes a loan to a company and this is subsequently written-off, the company will have a non-trading loan relationship credit equal to the amount written off.

If the loan was made to an unquoted trading company, the individual will crystalise a capital loss equal to the amount of the loan written off.

This will be available to set off against capital gains arising in the year of write-off or in subsequent years.

We may see situations in practice where it is possible for the loan to be converted to equity in the company and the shares in the company subsequently become of negligible value.

The amount of loan written-off will represent the consideration for the shares and if the shares later become worthless or of negligible value and the company is an unquoted trading company, the capital loss may be claimed against taxable income.

If a company makes a loan to a participator and this is subsequently written off, the following applies:

• Tax is payable on the loan advanced to the director under Corporation Tax Act 2010, s.455 (formerly Income and Corporation Taxes Act 1988, s.419), equal to 25% of the loan.
• S455 tax is repaid to company nine months after the accounting end date in which the loan is written off.
• The write-off of the loan is treated as a distribution, grossed-up at 100/90 and taxed in the hands of the participator at the rates applicable to dividends.
• No corporation tax return deduction is permitted for the write off by virtue of CTA 2009, s321A.

So what is the situation where a company makes a loan to a connected LLP and then subsequently writes this off? 

The government is currently concerned about corporate LLP members abusing the structure to avoid tax; in particular, the use of loans between LLPs and close companies.

An emerging trick has been for a company to lend money to an LLP and for it to remain outstanding indefinitely or to be written-off.

The use of the LLP structure has meant that, previously, a charge to s.455 tax would not apply.

Finance Act 2013 tightened up the rules introduced a charge to tax under CTA 2010, s455 where money is loaned to an LLP in which the creditor company is a member.

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