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HMRC internal manual

Corporate Finance Manual

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

No relief: example

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

A similar example of the current treatment under CTA09 appears at CFM35330.

BH Ltd lent GF Ltd £30,000 for 3 years, at 5% interest each year. BH Ltd owned 100% of the ordinary shares of GF Ltd, so the companies were connected under FA96/S87.

In Year 1, BH Ltd received the interest due of £1,500. At the end of Year 2, GF Ltd’s trading position had deteriorated and it was unable to pay the interest due for Year 2. There were also serious doubts that it would be able to repay the loan. BH Ltd therefore regarded the interest due as bad for Year 2 and formally released half of the loan.

Year BH Ltd accounts BH Ltd tax GF Ltd accounts GF Ltd tax
1 Cr £1,500 Cr £1,500 Dr £1,500 Dr £1,500
2 Dr £15,000 (loan released) Cr £1,500    
Dr nil Dr £1,500      
Cr £15,000 Dr £1,500      
Cr nil        

The tax treatment did not follow the accounts treatment, as BH Ltd had to assume that

  • interest was receivable in full in Year 2, and
  • the loan would be repaid in full.

FA96/SCH9/PARA6 disapplied FA96/SCH9/PARA5 because of the connection, so BH Ltd could not use the authorised arrangements for bad debt and therefore received no relief for the interest and loan waived in its accounts.

The release was symmetrical in group terms. BH Ltd did not get relief, but GF Ltd was not taxed because para 5(3) prevented that where the parties were connected.