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Business Income Manual

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Wholly and exclusively: duality of, or non-trade, purpose: loans/advances to others: for own trade or for subsidiary's?

Purpose is a question of fact

For companies chargeable to Corporation Tax, the tax treatment of loans and advances is now governed exclusively by the loan relationships regime in Parts 5 and 6 Corporation Tax Act 2009. Detailed guidance is at CFM30000. The guidance below remains relevant to the extent that it does not relate to transactions within the loan relationships regime.

The purpose for which expenditure is incurred is very much a question of fact. As is apparent from the case below, unless the tribunal wholly misdirected themselves, the High Court would not overturn a finding of fact - see BIM37045. It is therefore essential that you fully establish all of the relevant facts and explain their significance to the tribunal.

In the case of Redkite v Inspector of Taxes [1996] SpC93, the company carried on the trade of electroplating reels for the telecommunications and electronics industries. It had built up and nurtured a very high reputation for paying its suppliers without fail. Redkite had commenced the trade in the 1930s and expanded through its own ability and by buying small electroplating businesses. Two such acquisitions were subsequently renamed Subco 1 and Subco 2. Subco 1 acquired the precious metals it needed for its trade of electroplating from the Redkite’s suppliers. Redkite had bought Subco 1 so as not to lose a very important customer. In 1987 a group overdraft facility of £600,000 was agreed with the bank for general working capital purposes. The bank required registered debentures over all the companies within the group, together with completed unlimited cross-guarantees between the companies. Registered legal charges were also required over all properties within the group. On 16 February 1988 Redkite, Subco 1, Subco 2 and a dormant subsidiary of Redkite, executed a cross-guarantee. Each was a guarantor of each other’s liabilities to the bank.

In 1988 and again in 1989 the facility was increased, essentially to support Subco 1’s expansion. On 17 January 1991 the bank demanded payment forthwith of £1.9m by Subco 1, and a like sum from Redkite, Subco 2 and the dormant company, under their respective guarantees. On 18 January 1991 the bank appointed receivers of Subco 1. On 26 September 1991 Redkite paid the bank under the guarantee (less £200,000 which was met by the receiver of Subco 1).

The payment to the bank was entered in Redkite’s management accounts as a revenue expense. The Revenue accepted that the expenditure was a revenue expense but disallowed a deduction in the accounting period from 1 January 1991 to 31 December 1991 under what is now S54(1)(a) Corporation Tax Act 2009 (CTA 2009) on the ground that the payment to the bank under the guarantee had not been wholly and exclusively expended for the purposes of Redkite’s trade.

Redkite appealed contending that the expenditure had been made wholly and exclusively for the purposes of its trade because the guarantee to the bank had been given to protect its reputation with its suppliers so as to ensure that no default occurred in payment of their accounts and therefore the banking arrangements had been entered into and carried out exclusively for the purpose of Redkite’s trade.

The Special Commissioners (D A Shirley and P W De Voil) decided that Subco 1 had been bought by Redkite to protect its trade. However, in agreeing to be responsible under the guarantee for the sums advanced by the bank, Redkite had not been exclusively concerned with retaining its high reputation with its suppliers. The guarantee given by Redkite to the bank on 16 February 1988 had not been given for the purposes of its own trade nor were moneys paid thereunder on 26 September 1991 expended for the purposes of its trade or, if they had been so expended, they had not been wholly and exclusively so expended. Redkite’s appeal would therefore be dismissed and the Inspector’s rejection of Redkite’s claim would be upheld.

‘Counsel for the taxpayer company submits that Subco 1 was bought by the taxpayer company to protect its trade. We accept this submission. He then submits that in giving the guarantee to the bank in February 1988 the taxpayer company was concerned to protect its reputation with its chemical suppliers and to ensure that no default occurred in payment of their accounts whether the sums were due from the taxpayer company or Subco 1. Money was advanced by the bank to Subco 1. The taxpayer company, it was urged upon us, in agreeing to be responsible under the guarantee for the sums advanced, was exclusively concerned with retaining its high reputation and therefore the banking arrangements which the taxpayer company entered into were carried out exclusively for the purpose of the taxpayer company’s trade. This we do not accept.

We find as a fact that the guarantee given by the taxpayer company to the bank on 16 February 1988 was not given for the purposes of its own trade nor were moneys paid thereunder on 26 September 1991 expended for the purposes of its trade or, if they were so expended, they were not wholly and exclusively so expended.

We dismiss the appeal and uphold the inspector’s rejection of the taxpayer company’s claim.’

In the case of Sycamore plc and Maple Ltd v Fir [1996] SpC104, from 1987 to 1993 Sycamore supplied goods to its subsidiary (E). E made regular payments to Sycamore for goods supplied but there was an increasing outstanding balance. In 1990 Sycamore made a loan to E.

On 16 October 1992 Sycamore decided to recall the loan, since, amongst other things, it was under pressure from its bankers and needed liquidity, but it considered that E could trade profitably if it could be made more efficient. Sycamore did not receive any repayments of the loan from E until 29 January 1993, but E made payments to Sycamore to reduce the trade debt in October, November and December 1992 and in January 1993, and the first three of those payments exceeded the value of the goods supplied in those months.

From 29 January 1993 to 30 April 1993 E made eight payments to Sycamore towards repayment of the loan, which Sycamore and E recorded in their accounts accordingly. The effect of the repayments was to create a realised exchange gain in Sycamore. Sycamore had trade debts in another currency that had strengthened against sterling.

On 11 March 1993 E gave Sycamore a fixed and floating charge over all its assets. E ceased trading on 16 April 1993 owing money to Sycamore for goods supplied. Sycamore took over E’s stock and credited the value to the loan account. Sycamore also paid some of E’s creditors direct, amongst other things, to preserve agreements with manufacturers and suppliers to which it and E were parties.

In its accounts for the year ending 30 April 1993 Sycamore wrote off the amount owing to it by E for goods supplied and claimed to deduct that amount from its profits and also the amount it had paid to E’s creditors. Those claims were disallowed by the Revenue, and as a consequence Sycamore’s claim, amongst other things, to carry back losses and the claim of another group company (M) to group relief in respect of trading losses surrendered by Sycamore were disallowed.

Sycamore and Maple appealed contending, amongst other things:

that the whole of the trade debt owed by E to Sycamore should be allowed as a deduction, subject to a reduction in respect of the value of any stock recovered by Sycamore from E which had originally been supplied by Sycamore subject to retention of title, since it was a doubtful debt estimated to be bad within S74(1)(j) ICTA 1988 (now repealed) and Sycamore had not been obliged to appropriate to the reduction of the trade debt the payments received from E in repayment of the loan:

  1. that the loss in respect of the value of the goods supplied by Sycamore to E after the first repayment of the loan by E on 29 January 1993 should not be disallowed under [what is now S54(1)(b) CTA2009] as the loss was connected with Sycamore’s trade; and
  2. that that loss was a loss and not expenditure, and could not therefore be disallowed under [what is now S54(1)(a) CTA 2009], since S54(1)(a) only applied to expenditure, and that the sums paid by Sycamore to E’s creditors were expenditure wholly and exclusively incurred for the purposes of Sycamore’s trade within S54 (1)(a).

The Revenue submitted:

  1. that the trade debt owed by E to Sycamore should be disallowed under S74 (1)(j) ICTA 1988, amongst other things, since Sycamore had allowed the trade debt to increase to obtain a tax deduction for such debt knowing that E would cease to trade, when it ought to have applied the sums it received from E as repayments of the loan, which had no economic effect on the group as a whole, towards reducing the amount of the trade debt, or the amount of the trade debt should be reduced by the value of stock supplied to E by its other suppliers and recovered by Sycamore, because Sycamore could not choose to credit the value of recovered stock to the loan account; alternatively
  2. that the loss in respect of the value of the stock supplied by Sycamore to E after 29 January 1993 should be disallowed under [S54(1)(a) or (b) CTA2009] since it was not incurred wholly and exclusively for the purposes of Sycamore’s trade, because Sycamore knew that it would not recover the amount of the loan and the value of the goods supplied to E and had credited the repayments of the loan to the loan account in order to obtain a tax deduction in respect of the loss on the trade account; and
  3. that Sycamore’s payments to E’s creditors should be disallowed under ICTA88/S74 (1)(a), since they were not expenditure incurred wholly and exclusively for the purposes of Sycamore’s trade.

The Special Commissioners began by saying that the treatment adopted in the accounts should be followed but only if such treatment followed the generally accepted rules of commercial accounting and there was no contrary statutory requirement. It was a question of fact whether expenditure was:

  1. for the purpose of the trade of the parent,
  2. for the purpose of the trade of the subsidiary,
  3. or partly for one and partly for the other.

The test was subjective and the answer to the question depended upon a true construction of the arrangements between the parent and the subsidiary. If the interests of the companies were considered together when the decision about expenditure was made then the expenditure could not be ‘wholly and exclusively’ for the purposes of the trade of one of the companies. Also, it was easier to conclude that the taxpayer company had another purpose where there were associated companies.

The part of the Special Commissioners’ decision on which the above guidance is based is set out below:

‘The loss in respect of the value of goods supplied by S to E after 29 January 1993 was not a disbursement or expense within [S54(1)(a) CTA2009], since it was not something which S had chosen to pay out, but was a loss which S had suffered. The money which S had paid to E’s creditors was expenditure, to which [S54(1)(a)] was capable of applying. It was a question of fact whether expenditure was for the purpose of the trade of the parent, for the purpose of the trade of the subsidiary, or partly for one and partly for the other. The test was subjective and the answer to the question depended upon a true construction of the arrangements between the parent and the subsidiary. If the interests of the companies were considered together when the decision about expenditure was made then the expenditure could not be “wholly and exclusively” for the purposes of the trade of one of the companies. Also, it was easier to conclude that the taxpayer company had another purpose where there were associated companies. When S had decided to pay E’s creditors, S had been considering only its own position. S had been concerned to preserve the distribution agreements with manufacturers so that S could continue to use them, to preserve its relationships with the suppliers who supplied S and E, and to preserve the relationships with E’s customers who would in future be supplied by S. S had not wanted its own creditworthiness to be called into question by its own bankers. S had not been considering E’s position except to the extent of limiting the damage which E might do to S’s interests. There had been very little benefit to E from S’s payments to E’s creditors since E had ceased to trade. The money paid by S to E’s creditors was therefore paid out wholly and exclusively for the purposes of S’s trade and was accordingly allowable under [S54(1)(a)].’