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HMRC internal manual

Corporate Finance Manual

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

No debits for bad debts

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

The current rules can be viewed at CFM35310 onwards.

For accounting periods starting before 1 January 2005, the general provision in FA96/S85(3)(c) was that an authorised accruals basis of accounting had to assume that all amounts would be paid in full as they became due.

FA96/SCH9/PARA5 allowed creditor companies to depart from this rule, for

  • bad debts written off
  • provisions for bad debts
  • debts released treated as debits

where the authorised accruals method also allowed subsequent recoveries of bad debts to be brought into account as credits.

FA96/SCH9/PARA6(3) stopped that departure (with certain exceptions - see CFM81170) for companies that were connected under FA96/S87 (see CFM81010). It stated that the assumption that every amount will be paid in full would be applied, as if there had been no departure under para 5. In other words, connected companies could not bring in debits for bad debts or releases.

Effect on companies initially using mark to market or fair value accounting

A company using mark to market or fair value accounting did not show debits for bad debts in its accounts, as the value of a loan relationship was written down to its fair value, reflecting any doubt over repayment. However, FA96/S87(3) required connected companies to use the accruals basis of accounting for accounting periods starting before 1 January 2005. So, companies that had used mark to market or fair value accounting for a loan relationship with a connected person were prevented from getting bad debt relief.

Treatment of debtor company

Recognition by the creditor that a debt was bad would not have affected the tax position of the debtor, even where the parties were connected. In the more unusual situation of the creditor formally releasing the debt, a connected debtor would not have brought in a credit for the release (FA96/SCH9/PARA 5(3)). Release of connected party debt was therefore ‘flat’ - there was no relief for the creditor, but no tax charge on the debtor.

There is an example at CFM81130.