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Is a borrower taxed when the loan is written off?

Is a borrower taxed when the loan is written off?

I have also posted this on the Financial reporting any answers, so it is not deja vu if you think you have already seen it.

A non-corporate owns and lets a number of commercial properties.  This is its only business.

It borrowed from a bank on a limited recourse basis.  The loan was used to purchase another tenanted commercial property.  The bank's only recourse was to that property.  The tenant failed, the loan went into default, the bank forced a sale of the property.  Due to the ring fencing the other properties are unaffected

The write down on the fixed asset was recognised in the profit and loss.  How is the reduction in the debt recognised?  As the only recourse was to the property, the liability to pay went with it.  It is not the same transaction as the sale of the fixed asset. 

I need to nail this because I believe the tax treatment of the write off will follow the accounting treatment.

If it not part of the fixed asset asset disposal I believe it is capital.   The loan was not an asset so its writing off is not either, there should not be a capital gains tax charge.

If you have stayed with me this long, thank you, so I will toss in a sub-question.  When the tenant failed, the bank charged interest on the loan by rolling it up within the loan account; the facility did not provide for redrawing the loan so the treatment is questionable.  Nonetheless, should the interest that was charged be recognised as an expense or not charged and treated as part of the sum written off.

I am sure other people out there are starting to come across this problem, the Socttish and Irish Banks were heavily into commercial property lending and the competition for the business was fierce hence the limited recourse facilities.  The property market went south in 2008 and the banks have been moving in since the latter part of 2009.


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05th Nov 2010 12:09

That one threw me

Thanks for  the reply.  I must admit it set me reeling.  The loan was made at interest at a commercial rate and I felt that kept the treatment confined to capital HMRC's Savings and Income Manual seem to be rather less foreceful than the section itself. 

Are you aware of HMRC taking this approach?  I ask because for a corporate it heads off to loan relationships and as this is not going there, it may be an alternative that was tried out to make a round hole for a square peg.

As regards the dog, he died a number of years ago.  As it was an Irish Wolfhound, I can only be thankful that fleas' size is not proportionate to the size of the host

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10th Nov 2010 11:37

Personally ..

.. I doubt that a discount is involved. What discount? The loan was repayable at face value, it is simply that the value of the asset on which it was secured was realised for less. It 'feels' like a capital 'profit' to me, if profit is the right word. I don't know about the accounting treatment but in a sense the non-payment of the balance of the loan compensates in a way for the fact that the property was presumably sold for less than it could otherwise have been, so the loss on the property is underwritten to some extent by the extinguishment of the loan. I don't say these musings have much relevance from a tax point of view, but just trying to look at in different ways. If it is a capital profit I can't see that it is taxable so I don't think the accounting treatment does determine the tax treatment. It is not a capital sum derived from an asset and therefore I don't see that that CGT applies. Could it be any other profit arising or what we used to call Case VI? Possibly but as I say it seems of a capital nature to me.

However, I'd agree that it is the taxpayer's duty to correctly self-assess. You could try getting a ruling as it does seem to be a grey area. This is not under COP 10 but there is now a separate service for business 'customers'.

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12th Nov 2010 16:19

From a tax perspective...

Apologies if I have missed the question (it's almost close of play on a Friday and my brain is in (a tired!) weekend mode), but I had a very similar situation recently; ie non-corporate acquired a property by way of a limited recourse loan that went into default such that the lender repossessed and sold the property on.

My client is not a property trader or landlord, merely a chap with quite a few properties.

The conclusion I reached from a tax perspective is that this is a gains tax matter.

Base cost is whatever your client paid for the property plus incidentals.

Consideration - the property has been disposed of at whatever the lender manages to get for it plus the capitalised value of the loan relased, which forms part of the consideration.

Does that help any with accounting treatment for you?

Regards, A

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12th Nov 2010 17:08

Thanks to both Ken and Anthony.

My feeling is also that it is purely capital.  I think the discounts in section 381 are those on issues of securities, the predecessor of s381 made discounts taxable.  Before that the Court of Appeal overturned the decision in the lower Court (Lomax v Dixon).

If it is capital I feel it cannot get caught under the old D VI because the presupposition for such a charge is that it is income, unless it is specifically legislated for (e.g. offshore gains).  It would be the case if my client was trading in loans but it is not.  The only trouble with COP 10 type rulings is it gives the HMRC view and then if you do not agree it; if you go in with your take on it backed by accounting treatment, HMRC needs to displace the treatment if it cannot find a specific charging provision.

With Anthony's reply, I think he has the wrong analysis which leads to the wrong conclusion.  If the Bank takes the property in satisfaction of the debt there is some merit to saying the asset is disposed of at the value of the debt.  In this case, the property was not taken the bank forced a sale and took the proceeds in final settlement of the debt.  This is why I am emphatic that we have two transactions.  The first is sale of the property which acheived a price and that price is the market price.  The second is satisfaction of the debt in full by a payment and a write off of the balance.

I like to think of things in a simple manner and, were it not for the "trade" aspect of a property business i would have said it is not taxable at all.  If it was would HMRC not be going after everyone who has a credit card debt written off or reduced.

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12th Nov 2010 17:29

Quick draw

I think you are replying to Anthony.  Otherwise Travis Bickle (Tax Driver) would be asking "Are you talking to me?"

Have you any thoughts on Lomax v Dixon?  It's an old case but sometimes an old case fetches the best price in the auction room.

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15th Nov 2010 11:31

I think Kayne's analysis

... of the legal situation is correct as I understand it. The bank as mortgagee have the right to dispose of the property but only as trustee for the legal owner. I'm not sure precisely how it works since I assume the contract would be between the bank and the purchaser under the mortgagee's power of disposal. That must be right since in some cases the legal owner will have done a runner. As for the interest, from what I gather it wasn't paid so there cannot be any relief.

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