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HMRC internal manual

Corporate Finance Manual

Loan relationships: connected companies and impairment: debtors: deemed releases of impaired debt: where holders of impaired debt become connected: examples

CTA09/S362: examples

Example 1

S plc holds (not as trading stock) £10 million nominal of medium-term interest-bearing notes issued by T plc, the parent company of a retail group (the ‘T group’). In February 2007, however, the group of which S plc is part makes a successful takeover bid for the T group. As a result, S plc becomes connected with T plc on 20 February 2007. S plc draws up accounts to 31 December, while T plc’s accounting period ends on 31 March.

For accounting purposes, S plc designates the notes as ‘fair value through profit and loss’. At 31 December 2006, the fair value of the notes (which were issued at par) is £8 million, the decrease in fair value being substantially due to profit warnings issued by T group.

From 1 January 2007, S plc must for tax purposes account for the notes on an amortised cost basis. Since FVTPL assets are not assessed for impairment, no impairment loss will have been recognised for tax purposes, and the starting value for the amortised cost basis is £10 million.

The £2 million difference between the fair value at 31 December 2007 and the opening amortised cost figure is brought into account by S plc as a credit for year ended 31 December 2007, under CTA09/S350.

Under CTA09/S362, it is necessary to hypothesise what would be shown in a balance sheet drawn up by S plc at 19 February 2007. Such a balance sheet would show the loan notes at fair value: no identifiable adjustment for impairment would have been made. Therefore CTA09/S362 does not apply, and T plc is not required to bring in any credit.

Example 2

The facts are as in example 1, except that S plc accounts for the loan notes as an available for sale (AFS) asset. At 31 December 2006, impairment losses of £1.5 million have been recognised through profit and loss account. Cumulative fair value decreases of £0.5 million have been taken to equity (and not recycled to profit and loss account as impairment losses).

At 19 February 2007, the market value of the T plc loan notes had recovered somewhat as a result of the takeover news, and were S plc to draw up a balance sheet at that date, there would have been a reversal of £0.6 million of the impairment loss, reducing it from £1.5m to £0.9m.

S plc’s starting value for the amortised cost basis at 1 January 2007 will be £8.5 million - existing impairment losses are recognised, even though no further tax relief for impairment is given. The credit it brings in under CTA09/S350 will therefore be £0.5 million, being the difference between this starting value and the £8 million fair value.

Immediately before S plc and T plc become connected, however, the carrying value in S plc’s accounts would have been adjusted by £0.9 million for impairment. £0.9 million of the debt is therefore deemed to have been released, and T plc must accordingly show a credit of £0.9 million in its tax computations to 31 March 2007.

If there is a future disposal of the liability by T plc, its starting point for computing its loan relationships profit or loss will be £9.1 million (£10 million - £0.9 million).