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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Old rules: loan relationships: connection and bad debts: acquiring bad debts: no relief for acquired debt: examples

Connection: no exemption from para 6(3)

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

Where the creditor was connected to the debtor, and the provisions in para 6B didn’t apply, the creditor had to accrue the purchase discount, assuming that the loan would be repaid in full. Because the parties were connected, para 6(3) ensured that there could be no departure from the assumption that the amount would be paid. The creditor couldn’t have the benefit of the authorised arrangements for bad debt in para 5.

Para 6(3) would always have applied where the creditor and debtor company were connected before the purchase of the bad debt.

Example: term loan

Where the loan still has a period left to run (a term loan) the creditor company accrued the discount over the remaining period of the loan.

GR plc was the long-term parent of XM Ltd, a struggling company that owed the bank £120,000 to be repaid in 3 years. The bank, knowing that it was unlikely to recover the debt, agreed to assign the loan to GR plc for payment of £60,000.

At the end of Year 2, GR plc estimated that £30,000 would be recoverable, and made a provision of £30,000. On redemption, at the end of Year 3, XM Ltd paid £25,000 in full and final settlement of the debt.

Under the authorised accruals basis, GR plc had to assume that the loan of £120,000 would be paid in full. The purchase discount of £60,000 would have been brought in over the remaining 3 years of the loan. Assume for convenience it used a straight line method.

Because GR plc accepted an amount in full and final settlement, it was no longer party to the loan relationship.

Year GR plc accounts Tax Explanation
       
1 No debits or credits Cr £20,000 Accrued purchase discount for the AP, the difference between the nominal value of the loan and the price paid
2 Dr £30,000 Dr nil (Para 6(3))  
Cr £20,000 No bad debt relief.
Accrued purchase discount for Year 2.      
  3 Dr £5,000 Dr nil (Para 6(6))
Cr 20,000 Para 6(6) applied to compare the amounts accrued on disposal with the amounts accrued had there been no disposal. The higher of these two amounts, £20,000, was brought in, in the case of credits, and the lower, nil, in the case of debits.

Example: demand loan

If the loan is due to be repaid now, perhaps because the repayment date has passed (demand loan), the creditor company must bring the purchase discount into account immediately.

GR plc is the long-term parent of XM Ltd, a struggling company that owed the bank £120,000, which should have been repaid 2 months ago. The bank, knowing that it was unlikely to recover the debt, assigned the loan to GR Ltd for £60,000. In Year 2 GR Ltd formally waived the loan.

Y Accounts Tax Explanation
       
1 No debits or credits Cr £60,000 Under the authorised accruals basis, GR Ltd must assume that the loan of £120,000 would be paid in full. The discount of £60,000 was therefore brought in immediately.
2 Dr £60,000 Nil GR plc ceased to be a party to the loan relationship. Para 6(6) applied to compare the amount accrued on disposal with the amount accrued had there been no disposal. The smaller of these two amounts, nil, was brought in.

Disposal

When the loan relationship was finally repaid, redeemed, written off or otherwise disposed of, para 6(6) applied to adjust the amount brought in on disposal. This is covered at CFM81150.