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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Loan relationships: connected companies and impairment: debtors: deemed releases of impaired debt: where holders of impaired debt become connected: further example

CTA09/S362: further example

K Ltd and O Ltd are unrelated companies that have, for a number of years, each held 50% of the shares in a joint venture company, KO (Trading) Ltd. For the purposes of loan relationships, neither company has control over KO (Trading) Ltd. All three companies draw up accounts to 31 December.

In year ended 31 December 2005, KO (Trading) Ltd pays $24 million to acquire the whole of the share capital of a US trading company. The acquisition is funded by loans of $12 million from each of K Ltd and O Ltd. Although the functional currency of all three UK companies is sterling, the loans are made in US dollars so that they function as an economic hedge of the net assets of the US company.

K Ltd classifies the loan to the joint venture company as ‘loans and receivables’, accounting for it at amortised cost.

In retrospect the acquisition proves to be a costly mistake, and O Ltd decides to reduce its holding in the joint venture. On 2 January 2007, it sells half of its shareholding to K Ltd, so that K Ltd now holds 75% of the shares in KO (Trading) Ltd. The two companies are therefore connected for loan relationships purposes from 1 January 2007 onwards.

At 31 December 2006, K Ltd has in its accounts recognised an impairment loss of $4 million (translated into sterling as £2.4 million) on the debt owed by KO (Trading) Ltd. In its self assessment for year ended 31 December 2007, KO (Trading) Ltd brings into account a loan relationships credit of £2.4 million under CTA09/S362.

While CTA09/S362 deems there to have been a release of the debt, KO (Trading) Ltd is not required to extend the statutory fiction any further than bringing in this credit, and adjusting the ‘base cost’ of the debt to $8 million on any subsequent disposal. It is not required to consider whether the interest it pays would be excessive in relation to a debt of $8 million. And in particular the exchange gains and losses to be brought into account are those shown in the accounts, computed on a liability of $12 million. Forex matching will be unaffected by its becoming connected with the creditor company.