Old rules: loan relationships: connection and bad debts: acquiring bad debts
Effect of the connected persons legislation
This guidance applies to periods of account beginning before 1 January 2005
Bad debt (now impaired debt, see CFM35420), was debt of any kind that was unlikely to be paid in full. A purchaser would therefore pay less than full value for it, perhaps hoping to make a profit if the debtor recovers and could repay the debt.
A company might also buy bad debt
- because it had bought the debtor company, and wanted to replace others as the creditor for any debts owed by the debtor company, or
- as part of a restructuring of group finance, and wished to buy in debt that a group company owed to a third party lender.
In both scenarios in the current rules example at CFM35420, the creditor company is connected to the debtor in the accounting period when it buys the debt. But, under the old rules,
- Para 6(3) would have prevented the company from using the authorised arrangements for bad debts
- the creditor had to assume that the debt will be paid in full - in other words, it had to bring in its face value, not the price paid.
So if the face value of the debt was £100,000, but it was purchased for £40,000, the creditor would have needed to bring in a credit for the purchase discount of £60,000.
However, the overall economic effect is different in each scenario.
In the first scenario, where debt is purchased along with the debtor company, the old group has had the benefit of any losses incurred by DS Ltd that may have been surrendered as group relief. The new group has the debt, but no other benefits.
In the second scenario, where debt is purchased as part of group refinancing, the existing group has already benefited from any group relief for losses generated by the ailing debtor.
The old rules distinguished between the two scenarios. Under the provisions of para 6B(5)-(7) creditor companies that become connected while acquiring bad debt, as in the first scenario, were not required to bring in the full value of the debt where certain conditions are satisfied. See CFM81210 for details of the conditions and effect of the provisions in para 6B(5)-(7) worked.
See CFM81230 for a further example of how para 6(3) operated where para 6B(5)-(7) did not apply.