What is the correct tax teatement for the following.
Client sells his product but the purchaser is unable to pay, so they agree to treat it as a loan (or defer payment) and charge interest.
The purchaser ultimately is unable to pay all of the debt and most of the interest.
Is this a bad debt for income tax purposes or a capital loss?
Will the vendor have to pay tax on the interest charged but not received?
Replies (8)
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Capital or Revenue debt
Your remarks a contradictory, did they agreed to treat it as a loan or was the debt deferred? It is crucial to know this. I suspect not. It is my opinion, if the debt was converted to a loan; the loan used to pay of the invoices (book entry off course) the vat on the invoices accounted to HMRC then it is a loan and would attract capital losses. However if the invoices remain unpaid and are reflected as so on the ledgers, the fact you are charging interest is irrelevant as to whether it is Capital or Revenue, it would most definitely be Revenue, and yes tax would have to be paid on the interest whether it is paid or not, accruals basis, if at a latter date the Compnay goes into liquidation then relief would be avaliable for the unpaid interest.
Capital or Revenue debt
Your remarks a contradictory, did they agreed to treat it as a loan or was the debt deferred? It is crucial to know this. I suspect not. It is my opinion, if the debt was converted to a loan; the loan used to pay of the invoices (book entry off course) the vat on the invoices accounted to HMRC then it is a loan and would attract capital losses. However if the invoices remain unpaid and are reflected as so on the ledgers, the fact you are charging interest is irrelevant as to whether it is Capital or Revenue, it would most definitely be Revenue, and yes tax would have to be paid on the interest whether it is paid or not, accruals basis, if at a latter date the Compnay goes into liquidation then relief would be avaliable for the unpaid interest.
Bad Debt or Capital Loss
It may be possible to argue the case either way. In my view it is the original nature of the transaction which is the key. The transaction was clearly one of a revenue nature. I cannot see that the conversion to a loan will remove the sale from the income tax computation and therefore the loss is against income tax not capital gains tax.
It's a trade debt
I don't think that it would make any difference if you converted into a loan. It is an expense incurred for the purposes of the trade. Loan is an ordinary commercial term and so what is a loan is a question of fact, though I think it is a 'red herring'. If all the client has done is allow extended repayment terms I don't see how that creates a different animal, certainly I think HMRC's view is that a trade debt does not somehow morph into a financing loan by leaving it oustanding - so that if the creditor writes it off they would still want to tax it under section 94. Which they would here except that s94 would only apply to debts formally released - if I am remembering this correctly. The fact is that goods have been supplied which have not been paid for; the sales ledger has been credited with an amount which will not be collected. It's a trade debt and I can't see any inspector denying relief.
To be honest ..
... I doubt if you will find a definitive answer. What would be the correct accounting treatment because that would generally prevail for tax. As I said I'm not sure it really matters what you call it; the fact is that the company has invoiced for & presumably paid the VAT on goods or services for which it hasn't been paid; I'm not an accountant but I'd have thought you would just write off to the P&L as a bad debt. S74(j) of ICTA - or whatever it is now - denies relief for
"any debts except -
(1) a bad debt ..
It is true that not every debt is a loan (i.e., normally, a trade debt) but every loan is certainly a debt. I'm not sure that we need to get too complicated here. It may be relevant what has been done in the books i.e. whether you have treated the debt as being paid and then debited a loan account, but ultimately it is a question of tax law. You can't be taxed on profits you haven't made. The arrangements for repayment of the loan and acceptance of worthless shares were presumably making the best of a bad job. One doesn't know all the facts and it is foolish to be too definite without, but the principle seems pretty clear to me.
It is simply ...
...a loss arising out of the trade and I don't see how you can slice it any other way. I think if you really wanted to get into this you would find support in Absalom v Talbot where part of the purchase price of houses was left outstanding as loans. The case concerned the value to be credited to sales, but I don't think there was any argument by HMRC that any bad debts wouldn't be allowable on the grounds that the loans weren't trade debts. There is also support in Sycamore plc v Fir and Calders v CIR. The facts are dissimilar on the face of it but both concerned trade debts and funny arrangements but the original trade debts were allowed.
Cheers.