Farming Practitioners - First Milk Restructure

Bad debt relief on conversion from retention to shares in First Milk?

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The client I am dealing with is a farming partnership.

First Milk are a farmer-owned dairy co-operative. Members sold their milk to First Milk and in accordance with the agreement between the two parties a fraction of the income earned by members was retained and placed in a members capital account.

As part of restructuring that took place in August 2016, member’s capital accounts were converted into ‘C’ preference shares. Our client had a capital account of just over £100k, and so gets 100,000 £1 ‘C’ shares in exchange.

The ‘C’ shares are not going to be valued at the same as the capital accounts however. For example the following article indicated that the value of the shares could be as little as 12% of the value of the capital account, so the value of the shares acquired in exchange for the capital account would be around £12k. https://www.doddaccountants.co.uk/blog/first-milk-restructuring-tax-implications/

My question is what happens to the £88k difference.

The full £100k has been treated as turnover in the accounts throughout the years, and has been taxed. It doesn’t seem unreasonable to me then that these retentions are trade debts, and the £88k would be provided for as a bad debt, with the remaining £12k being settled by the issue of the shares. At the end of the day, the client has been taxed on £100k of income, but only received assets to the value of £12k as recompense.

However, the above article sheds some doubt on this, and HMRC’s guidance on a similar case, Dairy Farmers of Britain, seem to suggest that the member’s capital accounts become capital, rather than revenue. Therefore, there is no scope to claim an income tax deduction for the loss in value, and as it is a simple debt, there is no capital loss either.

http://webarchive.nationalarchives.gov.uk/20140206164055/http://www.hmrc.gov.uk/briefs/income-tax/brief0510.htm

https://www.pwc.co.uk/assets/pdf/hmrc-tax-decision.pdf

I was wondering if anyone had encountered this, and if so, what are your thoughts on the treatment?

Replies (4)

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By KevinMcC
22nd Aug 2018 14:36

The more I think of this the more I doubt whether a bad debt provision can be made.

Say they sell the milk for £10,000. First Milk pay them £9,000, and treat the other £1,000 as a capital contribution/loan.

It could be said that they have had the £10,000, and that they have agreed to loan/contribute £1,000 as capital. The cash might not have changed hands, but that is merely to save paying over £1,000 to receive £1,000 straight away.

Hopefully someone can come along and tell me I'm wrong and income tax relief can be claimed.

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By Marion Hayes
22nd Aug 2018 17:03

Unlike when that article was written these events are now in the past, not the future. if you research it you should be able to find the agreed value, the company's agreed position on tax relief and possibly even cases to review.
My suspicion is that they converted loans to equity, and bought the shares for just over £100k (+interest?).
Capital loss or, depending on the numbers now a negligible value claim?

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By Tax Dragon
23rd Aug 2018 06:46

A negligible value can only be in point if the asset in question has lost value (the measure is against value, not cost). The asset in question is the one owned at the time of the claim - currently, shares. The trouble is the shares were never worth £100,000. So neg val is a non-starter.

That low starting value is of the whole problem, since it's that (not the face value of the loan) that forms the base cost of the shares. So, even if my understanding of the neg val rules is wrong, there's still no loss on the shares (other than any arising on a further fall in value).

So I agree with the OP. The loss has been realised and it was on the debt. S253 is the only place to look to for relief, but none is provided because receipt of the shares is taken as full settlement notwithstanding the low value of the shares.

It's unfair, but there is no relief.

(Especially unfair,actually, as a company would get relief in the same circumstances.)

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Replying to Tax Dragon:
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By KevinMcC
23rd Aug 2018 09:45

I was hoping that someone would come on and hit me with some obscure piece of legislation that makes it releiveable but no luck.

The more I've considered the position the more certain I've become that there will be no relief and the base cost of the shares is the market value at the date they are issued. I have emailed a contact at First Milk to see if any work was done on a valuation at the time.

As you say it is unfair, but as we all know, tax isn't always fair.

Thanks for the responses.

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