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HMRC internal manual

Corporate Finance Manual

Loan relationships: partnerships: allocating credits and debits to the company partner: Tax Bulletin article TB62/02

Apportioning credit and debits where the partnership and company partner account in different currencies

CFM36040 explains how credits and debits are apportioned between company partners. Problems may occur where the partnership and company partner account in different currencies. This was dealt with in a Tax Bulletin article in October 2002 (TB62/02). The text of the article is as follows. See also CFM64000 for more on accounting in a foreign currency.

“FA 2002 inserted a new paragraph 19 into Schedule 9 FA 1996 to deal comprehensively with cases where a company is a member of a partnership and a money debt (which includes a loan relationship) is owed by or to the partnership. Each company partner computes separately loan relationship debits and credits arising on the money debt.

For this purpose paragraph 19(4) Schedule 9 deems that the money debt is owed by or to the company partner, and that everything done by the partnership in relation to the debt has been done by the company.

The company then computes the debits and credits (“the gross debits and credits”) that arise from applying the loan relationships rules to this deemed situation. The company partner brings into account a proportion of these gross debits and credits, the proportion being determined by reference to the partner’s interest in the partnership.

We have been asked whether paragraph 19(4) means that you effectively ignore the existence of the partnership. The question arises in two circumstances:

  • the company partner and the partnership have different accounting dates, or
  • the functional currency of the partnership differs from that of the company partner. For example, a company that prepares accounts in sterling may have an investment in a partnership that prepares financial statements in US dollars.

Our view is that paragraph 19(4) requires the company partner to imagine itself as “standing in the shoes” of the partnership. The company is not required to substitute its own accounting date, or its own functional currency, for that of the partnership.

Case law on deeming provisions shows that the application of a “statutory fiction” should be carried only so far as is necessary for the purposes of the statute. The purpose of the deeming exercise in paragraph 19(4) is to compute the debits or credits accruing to the company partner, in a way that takes account of the particular circumstances of that company. There is no need, in doing this, to pretend that the partnership does not exist at all.

Example 1 illustrates how a company partner’s loan relationships debits and credits are calculated where its accounting date differs from that of the partnership. Example 2 illustrates the computation where the partnership has a different functional currency.

Example 1

X Ltd is a trading company with an accounting date of 31 December. It is a partner in a partnership P, which prepares accounts to 31 March. It does not account for its investment in P on a mark to market basis.

On 1 May 2003, the partnership acquires a zero coupon bond (issued by an unconnected company). The partnership accounts for the bond on an accruals basis. Its accounts show a credit of £50,000 in the year to 31 March 2004 in respect of accrued discount on the bond, and a similar credit of £80,000 in the year to 31 March 2005.

X Ltd is entitled to 50% of the profits of P in the year to 31 March 2004, but to only 25% in the year to 31 March 2005.

Step 1 - calculate gross credits

Under paragraph 19(4), the “gross credits” are computed as if the zero coupons bond were a creditor loan relationship to which X Ltd is a party for the purposes of its own trade. The company must account for this deemed loan relationship on an authorised accruals basis (paragraph 19(10)). X Ltd (and any other company partner) computes “gross credits” for periods of account ending on 31 March.

X Ltd therefore has gross trading loan relationship credits of £50,000 in the year to 31 March 2004, and £80,000 in the year to 31 March 2005.

The company is not required to work out the discount that would accrue on the bond in year ended 31 December 2003, or subsequent accounting periods.

Step 2 - compute the “appropriate share” of gross credits for each AP of X Ltd

Paragraph 19(6) says that apportionment of gross credits between partners is to be according to the shares that would be found by S114(2) ICTA88. Although paragraph 19(2) disapplies S114(1) ICTA88 where loan relationships are concerned, the apportionment rules in S114(2) continue to apply, including the provision for apportioning profits or losses to the corresponding accounting periods of the company.

X Ltd’s apportioned credits are £25,000 (50% x £50,000) for the year to 31 March 2004, and £20,000 (25% x £80,000) for the year to 31 March 2005.

X Ltd will therefore need to time-apportion these sums between its own accounting periods, and bring in:

Year ended 31 December 2003: 275/366 x £25,000 = £18,784

Year ended 31 December 2004: (91/366 x £25,000) + (275/365 x £20,000) = £21,284

Example 2

Y plc is entitled to 40% of the profits of a partnership, Q. Y plc accounts in sterling; partnership Q accounts in dollars. Both Y plc and Q prepare accounts to 31 December. Y plc uses the closing rate/net investment method to translate its investment in the partnership, using an average exchange rate for the year to translate its share of Q’s profit into sterling.

In the year to 31 December 2004, Q borrows $5 million from a bank. The bank is not connected with Y plc or any other company partner. Interest of $200,000 is payable on the loan during the period.

During the year the partnership sold goods to a customer for €10,000. The invoice remained unpaid at the year end. Q translated the trade debt into dollars at the year end, bringing into its accounts an exchange gain of $500.

Step 1 - calculate gross debits and credits

The gross debits and credits are calculated in the functional currency of the partnership. Paragraph 19(10) requires an authorised accruals basis to be used. Thus there is a debit of $200,000 in respect of the loan interest. S100(1) and (2) FA96 also requires exchange differences on the Euro trade debt (which is a money debt, but not a loan relationship) to be accounted for under the loan relationships rules. This gives rise to a gross credit of $500.

Step 2 - apportion gross debits and credits to the company partner

Since Y plc is entitled to 40% of partnership profits, it must bring into account a debit of $80,000 and a credit of $200 (or a net amount of $79,800). In accordance with S94AB(1) and (2) FA93, this is translated into sterling at the rate used in Y plc’s accounts to translate the partnership profits. If the average rate used is, say, $1.6/£, Y plc would show a loan relationship debit of £49,875 (79,800 divided by 1.6) in its tax computations.

Similar principles apply where a partnership is a party to a derivative contract (paragraph 49 Sch 26 FA 2002).”