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AIA

PTP Tax Tip No 39 - How to pay tax twice on the same money

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21st Nov 2005
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Q. My client company is a 100% subsidiary of its parent and has a 31 December year end. The two companies have traded with each other and the subsidiary owes its parent £100,000 on trading account. There is no feasible chance of recovery and so the holding company wants to release the debt. The directors are aware that there will be a liability in the subsidiary on the released debt, but want assurance that there will be a deduction for the holding company on the bad debt. It's a manifestly commercially-driven decision; so surely there's no problem?

A. Last year there wouldn't have been; but now there is a substantial problem! This whole area has changed following FA 2005. For accounting periods commencing after 1 January 2005, trade debts are brought within the loan relationships regime by s100(1)(c)(iii) FA 1996 to the extent that they are impaired (which includes being written off) or a previous impairment is reversed. One might think that that as a result the connected party rules for loan relationships would mean that there was no tax effect on either side of the deal, as with debts that are 'real' loan relationships, following sch 9 paras 5-6 FA 1996. However, s100(1)(c)(iii) is drafted to include only creditor companies, and the limiting effect of s100(2) FA 1996 is that s.94 ICTA 1988 still applies to tax the debtor, while the creditor company is unable to achieve a deduction for the debt written off. The only exception seems to be where the debt is released as part of a voluntary arrangement or where the debt does not fall to be satisfied by the payment of money (in which case s88D ICTA 1988 applies to it). Another cynical money-raising venture by the Chancellor slipped in under the wire in a too hastily-approved Finance Act that chips away at the symmetry of taxation that underpins the tax treatment of groups. The fiscal minefield expands again!

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By Taxcon
21st Nov 2005 15:50

bad debts
Thank you for this comment. I too have seen the Revenue try to assert that a long-outstanding trade debt is really funding (eg in the context of thin cap disputes) but my view is that such arguments are just wishful thinking on the Revenue's part and an example of their (sadly) increasingly prevalent "it's not fair" approach to tax - perhaps a further consequence of the pernicious idea of there being a 'right amount of tax'. Unless the directors change their view of the categorisation of the debt when they compile the financial statements (and I would even then strongly question whether their change of view would be enough to make it a 'transaction for the lending of money', and thus a LR, if it was not one originally) I would argue that the debt retains its original character through thick and thin as a matter of fact and law. It is a matter of common commercial experience that trade debts can remain outstanding for a long time and where the parties are connected then there is even more justification for leaving the debt outstanding in the hope that it will be paid; but that does not mean that they spontaneously metamorphose into funding debts. So I would argue that it's just a case of s.74(1)(j) for earlier years - and if the debt's bad, it's allowable - period.

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By Taxcon
21st Nov 2005 16:09

'capitalisation' of debt
Very briefly off the top of my head - two potential problems, I'd have thought. First - have the shares 'become' of negligible value as the legislation requires - an interesting point but one that the Revenue routinely takes. Second - in many cases between trading companies, the substantial shareholdings exemption would make a negligible value claim impossible - but this is going off the point of the tip, really!

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By gbuckell
21st Nov 2005 15:21

No problems last year?
I am not sure there would not have been a problem with this scenario last year. The subsidiary would still have been liable under s94 but the Revenue would have been likely to challenge bad debt relief in the parent company despite being outside the loan relationship rules. Often thes debts build up over a period and the Revenue argue it has ceased to be a simple trading debt and more a financing debt.

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By AnonymousUser
21st Nov 2005 15:35

Insurmountable ?
So, is the problem insurmountable or could symmetry be created by changing the nature of the "write off", example as follows:

The parent subscribes for sufficient further shares in the sub to extinguish the interco debt. After a reasonable time, sufficient to conclude that the trading situation of the sub will not improve, the parent then subsequently makes a negligible value claim against the shares.

The sub avoids a tax liability on the write-off and the parent has the benefit of capital losses.

Comments appreciated.

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