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HMRC internal manual

Corporate Finance Manual

Loan relationships: connected companies and impairment: overview


Connected companies are required to use the amortised cost basis of accounting in computing loan relationships profits and losses (CFM35100). The amortised cost basis recognises impairment losses in accordance with IAS 39 or FRS 26 (CFM20000).

CTA09/PT5/CH6, section 353 onwards, restricts the loan relationships debits that a creditor company can obtain for impairment losses on or for amounts released on debts owed to it by a connected debtor or for amounts released, and similarly excludes the credits that are taxable on reversal of impairment losses by creditors.

Connected debtors are, with some exceptions, not taxable on credits in respect of amounts released.

The purpose of the rules is to prevent connected companies from claiming tax relief more than once for the same economic loss, and from getting relief for artificially funding companies through debt rather than subscribing for shares. The following examples explain this.

Example of double tax relief

VB Ltd controls YZ Ltd through a 100% shareholding. VB Ltd lends YZ Ltd £200,000 that it uses in its trade.

YZ Ltd makes a substantial trading loss which it surrenders as group relief to VB Ltd.

YZ Ltd is unlikely to be able to repay the loan, so VB Ltd recognises the debt as impaired.

The rules in CTA09/PT5/CH6 prevent VB Ltd from obtaining the benefit of two lots of relief for a single loss - the group relief and the debit for impairment.

Example of relief for funding

AK Ltd has a subsidiary BK Inc, a company resident in the US. AK Ltd wants to support BK Inc by funding its purchase of a new factory.

If AK Ltd buys shares issued by BK Inc, AK Ltd will not get a deduction for the cost of the shares. It might instead consider lending money to BK Inc, and then releasing the debt, in order to get a tax deduction for the write-off.

Again, CTA09/PT5/CH6 prevents this by denying a debit for a loss arising between connected persons.

Fair value accounting

A company using fair value accounting does not show debits for impairment losses in its accounts, as the value of a loan relationship is written down to its fair value, reflecting any doubt over repayment. As connected companies are required to use amortised cost accounting for tax purposes, companies that have used fair value accounting for a loan relationship with a connected person are prevented from getting impairment relief.

Foreign exchange gains and losses on connected debt are not affected

This rule does not extend to exchange gains and losses on the debt, which connected companies bring into the computation of their loan relationships profits and losses in the usual way.