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HMRC internal manual

Corporate Finance Manual

Old rules: loan relationships: connection and bad debts: overview


This guidance applies to periods of account beginning before 1 January 2005

The statutory provisions relating to bad debts (now impairment debt, see CFM35420) were amended for periods of account starting on or after 1 January 2005 to reflect the introduction of IAS 39 and FRS 26. Detailed guidance is at CFM35310.

A company could use an authorised accruals basis, either because

  • that was the appropriate authorised accounting method, or
  • the provisions of FA96/S87 for connected companies imposed it.

Such a company had to assume that all amounts payable would be paid in full as they became due, subject to the authorised arrangements for bad debts in FA96/SCH9/PARA5.

However, where parties to a loan relationship were connected, FA96/SCH9/PARA6 prevented the company from using the authorised arrangements for bad debts in many cases.

This meant that connected companies could not bring in debits for bad debts, unless they fell within one of the exceptions. There were also rules in Para 6 to limit the loss on the disposal of a loan relationship.

The purpose of para 6 was to prevent

  • connected companies from claiming tax relief more than once for the same economic loss
  • companies from getting relief for artificially funding companies through debt rather than subscribing for shares.

Example: Double tax relief

VB Ltd controlled YZ Ltd through a 100% shareholding.

VB Ltd lent YZ Ltd £200,000 that it used in its trade.

YZ Ltd made a substantial trading loss which it surrendered as group relief to VB Ltd.

YZ Ltd was unlikely to be able to repay the loan, so VB Ltd made a bad debt provision.

VB Ltd had effectively had the benefit of two lots of relief for a single loss - the group relief and the debit for bad debts.

FA96/SCH9/PARA6 prevented this by not allowing connected persons to bring in debits for bad debts.

Example: Relief for funding

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

If AK Ltd bought shares issued by BK Inc, AK Ltd would not get a deduction for the cost of the shares.

If AK Ltd was tempted to consider lending money to BK Inc, and then releasing the debt, it might have hoped to debit the write-off.

Again, FA96/SCH9/PARA6 prevented this by denying a debit for a loss arising between connected persons.