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How to treat discounted loan stock?

A company proposes to issue 6% loan stock of nominal value £6m. This is to fund a project which will not start to generate any revenue until 12+ months down the line, so it is pointless paying interest in Year 1, as this would simply have the effect of turning capital into taxable income, which would not help anyone except HMRC.

The solution chosen is to issue the stock at a 6% discount, and accrue / pay interest only from the start of Year 2, but this raises a question:

As the liability will be to repay the full £6m, presumably this figure should be shown in the Balance Sheet, but how should the discount be reported in the Financial Statements?

Of course there may be tax implications as well, but I will think those through separately.

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I'd think the whole issue through as a whole issue

"it is pointless paying interest in Year 1, as this would simply have the effect of turning capital into taxable income, which would not help anyone except HMRC"

"Of course there may be tax implications as well, but I will think those through separately."

Erm, this sort of discount is likely to be taxable as income, which therefore seems to defeat the very reasons for doing it.

The accounting treatment is effectively to recognise the full value of the loan and release the discount to P&L over the interest-free discount period, which will probably then secure its tax treatment.

More correctly put, both the interest and the discount are financing costs of the loan, which should be released to P&L over the term of the loan.

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I see your point

I think the answer is to re-structure the return offered on the loan stock, so that there is no interest in the first year but a slightly higher return after that. The nominal value of the loan stock would then be £5.64m, instead of £6m.

 

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