Client company is a property developer. Purchases were funded by bank debt, and interest is a trade loan relationship debit. The company has some property which is still undeveloped, and which it currently has no intention to develop (and some planning permissions have lapsed), due to the current state of the property market. The value of this property has fallen, and the company's bank is going to release part of the debt secured on the property. On the face of things this should be a trade LR credit, but read on ...
The company intends to revalue the property and reclassify it as investment property in its balance sheet, which will mean bringing the market value of the property in as a trade receipt and realising a trade loss. For various reasons this is to be done in the accounts to June 2012, which have not yet been completed.
The aim is to have the bank agree that the debt release is effective from 30 June 2012, so that there is symmetry of timing in the accounts. However I am concerned that as the release will be agreed in the current year (to June 2014), HMRC could argue that the LR credit should be taxed in the current year. If it is a trade LR credit, this will not be a problem, as the 2012 loss will obviously mop it up. But with reclassification of the property w.e.f. 2012, could HMRC also argue that the debt release after the effective date of the reclassification as investment property is a non-trade LR credit? That would prevent the trade loss from being set against it, and a very large tax charge would result.
The company continues to trade, but these adjustments are far bigger than current or recent profits, so there is no other scope for using the loss or sheltering the LR credit.
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I'd say that it was non-trade
In order for a debtor loan relationship to be a trade loan relationship, the debtor must be a party to it for the purposes of its trade.
The purpose of the loan changes when the asset that it funds ceases to be stock and becomes an investment. After June 2012, the purpose of the loan is to fund an asset held in its (prospective) rental business, so the company ceases to be a party to the loan relationship for the purposes of its trade, rendering the release an NTLR credit, as you suggest.
The interest would also have been an NTLR debit from that point.
The release of the debt will, I think, have to be effected by deed or by way of an agreement for which consideration will need to be given. In either case, I doubt that you can backdate the effect.
If the land was originally acquired as trading stock, then the absence of a current intention to develop it doesn't change that fact. If it doesn't have any intended purpose by which the property will be exploited as a fixed asset investment, I think HMRC might also seek to deny the existence of the loss that's being created in any event. More so in the current climate, if they can see a tax take in it.
Of course, the other way to keep the loan relationship as being for the purposes of the trade (and avoid the loss being disputed), is to use the property concerned, as a matter of fact, as trade premises (storage?).
Thanks Steve
It's good to know that my concerns are valid.
Your stock valuation point is something else that I had considered, but I can't see any grounds for HMRC to resist. The client bought when land prices are high, and now they are much lower. This is no different in principle from writing down any other type of stock. HMRC might check the valuations, but they have all been done professionally and I think they are robust. We wouldn't even have to reclassify the land as stock to be able to claim the write-down as a deduction.
Agreed
Yes. I'd missed that a closing stock valuation should reflect the impairment anyway. Now I'm not sure why it's being done.