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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Loan relationships: computational rules: GAAP: example

GAAP: example

Q plc acquires shares in a new subsidiary for £10 million. It pays the vendor company £8 million in cash, and issues loan notes for the remaining £2 million. Subsequently, Q plc finds out facts about the financial position of its new subsidiary that had not come to light in the due diligence process. Discussions with the vendor company follow, as a result of which it is agreed that the purchase price should be reduced by £1 million. Accordingly, £1 million of the loan notes issued by Q plc are cancelled.

It accounts for the transaction as:

Dr Creditors (loan notes) £1 million
     
Cr Cost of investment £1 million

For tax purposes, the loan notes are loan relationships since, although there has been no lending of money, an instrument has been issued representing security for the creditor’s rights under the £2 million money debt.

The cancellation of £1 million of the notes does not, however, give rise to a tax charge under the loan relationships rules. Although a credit appears in the company’s books, there is no amount that has been recognised in determining the company’s profit or loss for the period.