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Waive Directors Loan credit balance

A director has a loan account showing £100k credit balance in his company.
The company is showing historical losses b/f although the company is in fact profitable.
The director believes the losses and his loan account were created by some creative accounting by his previous accountant.
He wishes to waive the amount owed to him as he does not believe the company actually owes him this money and the company is having problems obtaining credit with suppliers due to the negative balance sheet.
If the loan account is written off how is this treated in P&L?
What if any are the tax implications?
Mr S

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24th Apr 2009 10:50

Money debt
In order to be a loan relationship a debt must arise from the lending of money. Not being paid for something ( i.e. providing it on credit) is not the lending of money. So if the debt arises from unpaid consideration for goodwill or various sundry credits to the DLA such as undrawn salary it is not a loan relationship. This is why trade debtors do not fall into the loan relationship rules either (trading or otherwise).

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24th Apr 2009 09:43

Stupid question, no doubt:
The loan relationship rules distinguish between "trading" loan relationships and "non-trading" loan relationships. Credits under either environment appear to be taxable. Some of the comments in this thread seem to opine that it is not a LR (at all) because it is not a "trade debt". Granted that had it been a trade debt it would have fallen within the definition of a "trading loan relationship", I am not entirely clear how it is concluded that the debt is excluded from the "non-trading loan relationships" if it is not a trade debt. Sorry to ask, but it is still not clear to me whether the contributors in this thread are all in agreement.

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26th Feb 2009 16:57

Why...
Why could not the director give write-off to the value of the loss (in either this or prior year).

Will only work if the loss is recent I suppose, which this may not be. Such a move could make the P&L account much better, which seems to be the desired objective.

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26th Feb 2009 13:01

There are a couple of changes ...
from 1/4/2009 re late paid interest - rule to be disapplied in most cases & also removing the anomaly of a s94 charge where trade debt is formally released between connected companies (whlle the creditor gets no relief due to para 6). The change brings the credit in the debtor company within the loan relationship rules and overrides section 94, so that para 5 then applies and the credit is not taxable. Won't affect many companies as formal release will not often occur. Could happen say where you wanted to sell a company outside the group and tidy up before sale.

I have an article on the changes in next week's Taxation so this discussion has all been grist to the mill, though it doesn't deal with this particular topic. Just as well considering one of my earlier posts strayed into talking @?&*ocks!

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By Anonymous
26th Feb 2009 10:44

Particpator Loans - Taxability Contrary to EU Law
I seem to recall seeing at Pre-Budget 2008 time that there was going to be a review of the rules by the government surrounding the taxability of the release of participator loans in tandem with the release of the connected trade debts draft legislation. The review was because the denial of relief was contrary to EU law. The loans used to fall within Sch9 Para5 until the rules were changed in 2002. Does anyone know if that's right and if so what the progress is?

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25th Feb 2009 12:05

Clear off Tom
You can't keep us away from a good brawl by trying to revert to the original query!

Didn't think we were that off topic anyway.

Anybody know what the record is for the longest thread an AW?

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By Anonymous
25th Feb 2009 11:06

Excellent Ken
It's clear as bell now, thank you.

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25th Feb 2009 11:04

What was the Question?
Mr S, you've done well.

You've asked what looks like a perfectly genuine question and ended up with a mass brawl on a totally separate subject.

It looks like you've got only two sensible options. If you really think the accounts are wrong, it shouldn't be too difficult to go back and restate the accounts in earlier years. This would infer that assets (or losses) are overstated, being the other half of the double entry. Unless you've got firm evidence of "false" accounting, I'd let sleeping dogs lie and run with the figures you've got.

Rather than create a double entry which involves the P & L Account, I'd go for the option suggested by poster number 2 (all those posts ago).

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25th Feb 2009 10:48

Actually ..
... I suppose you would still credit DLA in practice even if you were going to write-off part of the account. However as James says it's not a LR and in fact, thinking back to the original post it's hard to see how that can be a LR either.

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25th Feb 2009 10:29

So .....
.... the goodwill was acquired at below MV and HMRC insisted on substituting MV? Still can't see what it has to do with HMRC what is entered into the company's books, or why HMRC would want to argue the toss in the first place - they usually want to talk the value down not up on an incorporation. Whatever. I personally don't see that when you incorporate a business the credit to DLA is an LR - it's the purchase price of an asset. Certainly the credit to DLA which you refer to isn't a transaction for the lending of money. You could write off that part of the DLA at least without consequences in my view. S94 clearly has no bearing as it's not a trade debt and in any case as I said earlier s94 only applies to a formal release.

More generally it may well be the case that people will need to inject money into their companies. If they do so with no terms of repayment then it quite clearly is not a transaction for the lending of money and so therefore not a LR. It's a gift really. In fact does it need to hit DLA at all?

Sorry if I still haven't quite got the right end of the stick, but hope that's of help.

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By Anonymous
25th Feb 2009 09:50

Ken/James
I think this situation is going to be more common in the current climate with directors introducing personal mortgage advances in order to repay creditors, then wishing to credit back the loan accounts in order to get a better credit rating and solvent balance sheet.

In my situation, HMRC argued goodwill was below MV. On closure they advised the accountant at the time to debit goodwill and credit DLA.

Credit rating reports specifically exclude intangible assets, but not the corresponding creditor. Thus, the company was apparently insolvent and was unable to get trade credit from suppliers.

Just for my own info, if it isn't a loan relationship then does CFM still apply?

If not, then does S94 ICTA88 only apply if both parties are companies? Under S94, the credit only appears to be taxable if tax relief was claimed on the debits.

I'm looking for some scope here, but if there isnt any, then I'll reclassify it as a fresh share capital issue.

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24th Feb 2009 17:06

Goodwill
There is no loan relationship as the creditor is due to unpaid consideration.

I don't see why the write back wouldn't be taxable, but I also can't see why you wouldn't want to either leave it there or capitalise it. Ken also has a good point, perhaps its actually a PYA rather than a write off as it didn't need to be there in the first place.

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24th Feb 2009 16:47

Not sure I follow
Hi Fellowcraft, but don't quite follow why goodwill would need to be uplifted following an HMRC enquiry unless it was purchased by the company at less than MV. But what is capitalised in the company's books is nothing to do with HMRC and as I understand it you don't revalue internally generated goodwill, so not quite sure why you would have a credit to DLA unless the agreement for sale of goodwill was tied to the amount agreed with HMRC.

Also not clear why this should lead to the write off of part of the DLA.

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By Anonymous
24th Feb 2009 15:11

Vested interest
Guys, I've been keeping an eagle eye on this post as I recently wrote off a material credit loan account balance to the P&L after taking advice (in writing) from my external tax adviser.

My clients situation was that the credit was a result of an uplift in goodwill, mirrored by a credit loan account, after an HMRC enquiry. The amortisation was not allowable.

The advice I received was that it was a 'flat transaction' and shouldnt be brought into account, and quoted the LR rules and Sch 9 FA96.

I am no complex tax expert, but my understanding was BIM40265 could add some weight as it states trading loans credited back are taxable, which (may or may not) indicate that 'capital' loans are not.

I have today received advice from my adviser that the Corporate Finance Manual does not apply (CFM 5051) as this relates to companies, not individuals. On that basis, they advised me not to amend the accounts and leave it be, and it wouldn't be difficult to challenge HMRC should they enquire.

However, it seems that the company has a loan relationship with the director, and it is relevant.

My understanding is the CFM does apply, and the loans, whether 'capital' or 'trading', are aggregated and charged to DI or DIII, irrespective of their nature or circumstances (assuming the company is trading and is not insolvent/scheme of arrangement etc).

On that basis I'm considering revising the accounts and converting to share capital.

Penny/Ken - just wondered what you thought of this, and whether you would do the same thing in this situation.

Regards

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24th Feb 2009 13:57

I thought I'd sussed this one ...
... and was surprised after a long weekend to see umpteen more posts.

However, sometimes one does get ones wires crossed and I have to admit that there is a 'tension' between my earlier analysis and the legislation. OK I was wrong!

S87 can't apply unless both parties are companies and so para 5 can't apply either. Penny is quite right.

It does seem questionable whether the debt is a loan relationship in the first place as it does not sound like a transaction for lending money - surely the director must know if he has put money in or just not drawn monies voted as divs or remuneration. May be worth some investigation to get to the bottom of.

Otherwise I can't see specifically find any reason why any LR credit would not be taxable. I gather that these days there has to be a credit to P&L and if that is the right accounting treatment then s85A would appear to apply. I did try reading FRS 26 but I don't mind telling you that I gave up on all that mallarky in very short order! Completely beyond me!

Of course the first thought in that case is why do at all? There's no real need. Convert to share capital or share premium if that looks better.

It still doesn't 'feel' right that the write-off should be taxable, though, especially if it's only an accounting entry and the debt remains legally due. But in that case would it be correct accounting treatment to write-off the liability one wonders. I'm definitely not going down that route again but others may care to. After all if the correct accounting treatment is not to write-off the liability then nothing has been achieved and it may be necessary to formally write off the the debt in order for the write off to be recognised.

Another tax issue though is that this definitely is not a bargain at arm's length and so para 11 may apply. If so, the debits and credits for tax are what they would be on an arm's length basis, so may exclude the debt write-off. Para 11 applies to a 'related transaction' which in turn is defined by s84(5) as including the disposal of rights or liabilities under a LR. S84(6) says that this includes where rights or liabilities are transferrred or extinguished by any sale, gift, exchange, surrender, redemption or release. That looks to me to fit the bill, but as I said before this is heavy stuff! Certainly if it is still intended to go down this route at all and if the debt is indeed a LR in the first place, if I were dealing with the case the matter seems sufficiently unclear to apply for a COP 10 ruling (or get counsel's opinion).

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21st Feb 2009 12:47

Interesting, but keep it clean
Having followed this thread with interest I hope this will not plunge to depths of name calling. My first thought was that the gain from the write off would be taxable, but that may not be so & it may turn out be an easier way to support a small company.

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By Anonymous
21st Feb 2009 09:55

Whats Your Argument?
Penny - No offence, but I'm getting the impression that I'm just feeding a troll here.

Just so I understand where you're coming from, and also to prove that you actually have something constructive to say, could you give me your argument for saying that a director loan account waiver in favour of the company is not a taxable credit please? Just to clarify, I think that it probably is.

PS You said "can you honestly tell me" - I know that I would ever dishonestly represent a case to win an argument (the fact that you hold that mindset is quite informative), I'm just trying to get an answer to something that I can't find an answer to anywhere else.

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By Anonymous
20th Feb 2009 21:10

Why Are Directors Loan Accounts Connected?
For one thing David Southern (http://www.taxcounsel.co.uk/index.aspx?p=7&barristerId=155) says so in his Totell book about loan relationships and derivative contracts.

I'm guessing that the connection aspect is dealt with somewhere other than s87 but haven't looked - just took what he was saying at face value.

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By Anonymous
20th Feb 2009 17:23

Connected
Director loan accounts are loan relationships where they are money debts. They are also connected loan relationships. Otherwise there would be no restriction as regards payment of interest.

What David Southern seems to be saying in 3830 is that it used to be the case that most credits arising from connected loan relationships were non-taxable but that now that ability to avoid tax is restricted to connected loan relationship credits arising because of insolvency or between connected companies and this seems borne out by the current version of Para5.

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By Anonymous
19th Feb 2009 19:16

But Ken .....
... surely s87 (amortised etc etc where parties are connected) applies only where the parties are both companies.

Equally, I don't see that para 5 of Sch 9 is of any relevance here - which of the 5 conditions do you consider to be applicable to this particular case?

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By Anonymous
20th Feb 2009 15:35

Taxation Issue 3830
Found this in an article by David Southern

"Other changes
For accounting periods beginning on or after 1 January 2002, a restriction is imposed on the rule (paragraph 5(3) of Schedule 9 to the Finance Act 1996) that no credit need be brought in by the debtor company when connected party debt is released. Where the parties are connected, release of debt will be brought into charge to tax by the borrower, unless either the release forms part of a relevant arrangement or compromise (Condition A) or the lender is within the charge to United Kingdom corporation tax (Condition B). This will alter the treatment of situations where a foreign company is a participator in or controls a United Kingdom company, and has made loans to the United Kingdom company which it intends to write off, e.g. to cover start-up costs. This will affect releases of loans by non-United Kingdom members of a group. Thus a parent or participator in another European Union Member State will suffer a disadvantage to which a United Kingdom parent or participator is not exposed. This is unlikely to conform with Community law."

The article was written in 2001 however so don't know if the conflict with Euro law was ever ironed out!

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19th Feb 2009 15:52

Phew
If its not a trade debt and therefore s94 doesn't apply, it's not a receipt of the company's trade and I don't think it's income anyway. Essentially it seems to me you are increasing the company's capital. In fact would you not credit reserves or do all such items have to go through the P&L?

Whoops now you've done it - I'm feeling a frisson of accountancy coming over me again. I shall resist!

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By Anonymous
19th Feb 2009 13:47

He aint heavy, he's my debtor.....
Hi Ken

If the debt is not a money debt or has not arisen through the lending of money, thus doesn't fall within the LR rules, is the credit to the P&L still taxable?

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19th Feb 2009 12:38

And the upshot may be ...
.. that if the debt is a LR in the first place and if I'm right in everything else I've said it would appear that if the debt is legally waived then the credit to P&L would certainly not be taxable because it would come within para 5?

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19th Feb 2009 12:27

This is quite heavy stuff
And I'm not sure all the answers are there for the looking up.

A LR must not only be a money debt but also arise from a transaction for the lending of money. HMRC do not regard overdrawn/undrawn directors loans as such if they consist of undrawn/overdrawn remuneration/dividends (CFM 5057a). It seems we don't know what the loan relates to but if the director doesn't know it doesn't sound like a transaction for the lending of money.

If it is a LR in the first place, while the director as an individual cannot have a loan relationship the company can have a loan relationship with him. If he controls the company then the company must use an amortised cost basis of accounting for tax purposes. Therefore I don't think the credit is taxable. It would be the same if say a connected company had lent the money but decided that the debt was impaired. The creditor would be prevented from getting relief due to para 6 Sch 9 but I don't think that any credit in the debtors books would be taxable, but I can't find anything that says so specifically and I'm not that familiar with FRS 26.

I'd agree that section 94 doesn't come into it as it applies only to trade debts and then only if the debt is formally released by means of a deed of waiver. That brings me to para 5, Sch 9 which says that if a debt is formally released and it's a connected party debt then no LR credit is brought in by the creditor. It would be an odd situation if a credit were required if the release were informal but again that may be that an under an amortised cost basis you wouldn't recognise the credit anyway. I think that would certainly have been the case under the authorised accruals basis as you were required to assume that all sums under the LR would be paid as and when due, and as far as I am aware the FA 2004 changes were only intended to change the terminology in line with IAS. I sometimes wish I was an accountant so that I understood financial reporting better but the feeling usually goes off quite quickly and doesn'y usually bother me again for months.

There must be CGT value shifting and IHT implications but probably are not applicable if the director owns 100% anyway.

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By Anonymous
17th Feb 2009 14:52

Back to the start...
of the answers...

You may like to try to satisfy yourself as to the provenance of this loan balance. £100k's worth of use of home or other trivialities sounds unlikely - could this be undrawn dividends/bonus to which he is entitled and has been assessed to tax upon?

There might be some ML angles for you to consider.

That aside, I would favour converting to share capital (subject to other interests in the shares). £500 in stamp duty may be money well spent.

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By Anonymous
17th Feb 2009 14:35

BIM 40265
Sorry guys, you are entirely correct & LRR wont apply.

BIM 40265 only seems to apply if it was a trading loan (as you say, debits posted to P&L). Do you agree that if the loan is of a capital nature then not taxable?

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By Anonymous
17th Feb 2009 14:20

Sch9 Para5(3)
I think that James has made a very good point - is it actually a money debt?

Fellowcraft - I don't think that 5(3) applies where you're talking about a non-company individual because the para talks about the amortised cost basis being used and any one of the five conditions set out in Para 5(4) to 5(8) being satisfied and they are all company to company based. I would bring the credit into account, therefore.

Having said that the outcome is a bit illogical to me so I would like to be wrong! After all, you could assign the debt to a company that you control and bear no tax (its a QCB) and then release the loan and rely on Para5(5) as there would be a s87 connection.

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17th Feb 2009 13:27

probably taxable?
As SH points out the 'flat' teatment for connected parties only applies if both parties to the debt are companies.

Is this even a loan relationship? If it's arisen due to 'creative accounting' then its probably not a money debt and so doesn't even fall within the loan relationship provisions and FA1996 is irrelevant. Most likely it's just the credit side of debits previously claimed as expenses therefore taxable as trading income in the same way as the write back of a trade creditor.

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By Anonymous
17th Feb 2009 11:17

FA1996 Sch 9 Para5
The exclusion in para5 relates to connected companies - connected being defined in s87. I don't think that any of the 5 exclusions in para5 relate to this situation.

I should say, however, that condition 4 may be relevant if there is a creditor insolvency situation as defined in para6A(1).

Remember that there is a difference between trade debts and loan relationships. The release of a trade debt is taxable under s94 ICTA 88 .

PS Fellowcraft - you give the example of goodwill but BIM 40265 says that trade debts under s94 do not include debts incurred for capital ... expenditure. I think what they're talking about here is goods and services.

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By Anonymous
17th Feb 2009 11:15

Thanks Mervyn
I will look into that a little further. Thank you.

Penny, sorry I am referring to S94 ICTA 88 also. I took independant advice on this which was :

"Treatment of debtor company

Recognition by the creditor that a debt is impaired will not affect the tax position of the debtor, even where the parties are connected. In the more unusual situation of the creditor formally releasing the debt, a connected debtor will not bring in a credit for the release (FA96/SCH9/PARA 5(3)). Release of connected party debt is therefore “flat” – there is no relief for the creditor "

My interpretation is :

Sch 9 states "only applies if part of an arrangement or compromise within s74(2) taxes act 1988". Correct me if I'm wrong but there is no such thing as s74(2)?

S94 does state "Where...a deduction has been allowed for any debt incurred for the purposes of the trade, profession or vocation, then, if the whole or any part of the debt is thereafter released, the amount released shall be treated as a receipt of the trade, profession or vocation arising in the period in which the release is effected."

Therefore the credit write back of a bank loan etc would be assessable, and in these particular circumstances the credit would be assessable say if the £100k was due to goodwill introduced and amortisation was claimed against profits, or interest was charged by the director.

Whether the whole amount, or the amount limited to the debits charged to the P&L, is an academic point !

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16th Feb 2009 17:00

PET and companies
Fellowcraft

My understanding is that Section 3A (1)(c) IHTA 1984 limits a PET to being one which is a gift to another individual, a gift into an old A & M Trust (now defunct of course) or a Disabled Trust.

The transfer of value by the director giving up his entitlement to the loan repayment is not to any of these classes but to the company, it enhances the value of the company shares.

There may be some relief by virtue of Section 3A (2)(b) where another individual's property is increased in value but this does not necessarily mean that the whole of the transfer value is covered. The other individual(s) may have minority interests which would not increase in value by the whole of the £ 100k.

If not a PET it is an immediately chargeable transfer at the (currently) 20% lifetime rate with a potential increase to 40% on a death within 7 years. Subject of course to other exemptions and allowances.

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By Anonymous
16th Feb 2009 16:21

IHT?
Mervyn, just for my own info, why is this not a PET and why would it be immediately chargeable if both directors are alive and not likely to die in the next 7 years? Cheers, Fellowcraft

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16th Feb 2009 16:00

Watch out for IHT!
If there are other shareholders involved, you also need to be careful that this is not a transfer of value from the director/shareholder. It is not a PET so potentially immediately chargeable, subject to prior transfers.

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By Anonymous
15th Feb 2009 16:28

Which is a great idea but...
...stamp duty would be payable on the issue, and the company will require a formal MVL via a licensed IP in order to eventually close it down. Either that or you will have to do a share capital reduction exercise.

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13th Feb 2009 16:55

I like share capital
Hey - strengthen the balance sheet by debiting DLA and crediting Share Capital. You could even create another class of share or a special reserve to mop this amount up if there were any pangs of doubt about the whole thing. Gosh, what wouldn't we all give for a credit balance on DLA?

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By Anonymous
13th Feb 2009 14:41

Sch 9 FA96
The credit write off is not taxable, it is effectively a flat transaction for both parties, ie you cannot make a s253 election for the director personally.

I had a similar case recently as the Creditsafe rating was poor, even though the company was in good shape.

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20th Nov 2009 11:00

Is this concluded?

My observations on reading this thread are
1) Provided that the DLA is a "loan relationship" then the credit arising from its write-off is taxable as a non-trading loan relationship surplus.
2) Some forum heavyweights have expressed an element of doubt about whether the DLA is necessarily a "loan relationship", although all are agreed that there is at least the potential for it to be one, this question possibly hanging on the nature of the transactions that caused it.
3) As far as I can tell, no firm opinion has been expressed in this thread regarding the tax consequences that would ensue if it is not a loan relationship.  Is it taxable because there is no exempting provision in the statutes?  Is it exempt because there is no charging provision in the statutes?  What does GAAP have to say on the matter and do the tax consequences follow from that treatment?  Under what schedule is it chargeable (if it is chargeable) - at least in years prior to the abolition of schedular basis of assessment to CT?

s.94 CTA 2009 (formerly s.94 ICTA 1988) appears to bring the credit back into charge provided that its creation resulted from an earlier transaction which gave rise to a deduction in arriving at the profit.  That would appear to catch a loan account that had been created by reason of an undrawn salary, but not for undrawn dividends.  I find it surprising that s.94 does not apply where the business concerned is a profession rather than a trade.  I don't understand the political justification for the distinction, but that is "by the by".

Ken Moody stresses that in order for the loan to be a "loan relationship" it must not only be a money debt but also arise from the lending of money, for which (second condition) undrawn salary and dividends would not qualify. CFM31040 appears to disagree with Ken Moody.  While the HMRC manuals only express an interpretation of law I feel that the thread is incomplete without noting HMRC's opinion on the matter.  CFM31040 reminds us that certain money debts which do not arise from the lending of money are nevertheless governed by the loan relationships legislation by deeming provisions contained in CTA09/PT6:

 "Not all money debts arise from the lending of money.  The legislation refers to such debts as 'relevant nonlending relationships'. They are brought within the loan relationships rules under CTA09/PT6."

I had a quick look at CTA09/PT6 and gave up - for my small brain it was a load of unintelligible gobbledegook.  However CFM31040 goes on to illustrate several examples of what HMRC consider to fall within this section, and in this they expressly include DLAs created out of undrawn salaries and dividends.

That being the case, I wonder if Ken might present an argument to support his conclusion?

With kind regards

Clint Westwood

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