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Sole Trader - Tax treatment of bank loan write off

I have a client who ran a hotel for a number of years as a sole trader. The hotel was purchased pre-2008 and since the crash, it’s value has fallen considerably (about £800k) which resulted in the bank applying considerable pressure to sell up.

The hotel has now been sold, but there will still be about £100k due to the bank. A meeting is to take place between us, the bank and the client in the near future to discuss what is to happen with this £100k, and the potential for it to be written off has been raised (our client has no other savings/assets to offer to pay this).

My thinking now comes to the tax consequences of this write off and I’m considering 3 possible options:

  1. As a sole trader, the loan relationship rules do not apply. As far as I’m aware, there are no similar provision for individuals.

    The loan is a liability, not an asset, and so I don’t think capital gains tax is in question (TCGA 1992 s21).

    In addition, I think there is a fair argument that the loan is not part of the disposal of the property because legally it is a separate transaction to the property disposal.

    On that basis, the write off is a tax nothing as it simply does not fall into any of the charging provisions of the taxes acts.
     

  2. Similar points as argument 1), however treating the loan write off and the property disposal as linked, so arguing the w/o is a capital receipt, and therefore including the amount w/o as proceeds of sale.

    This option would still leave us in a large loss position.
     

  3. This is the option that’s causing me some worry/doubt.

    Under GAAP, the w/o would be a CR to the P&L. For tax purposes, the tax treatment follows the accounts treatment, unless there is legislation or case law which states otherwise.

    If we were to argue it is a capital receipt, then fine, we can adjust for it for income tax purposes and treat it as a capital disposal in line with option 1 or 2.

    But if it was to be successfully argued, as we’d look to do in point 1), that it is not a capital receipt, then we would not then be able to make a tax adjustment on this basis.

    With there being nothing in the income tax rules, that I’m aware of, that would allow us to make a tax adjustment, my fear is that the w/o simply follows the GAAP treatment and is taxable as sole trade income.

 

Option 3 would be pretty disastrous for the client as it’d lose them their personal allowance and mostly be taxed at higher rate so I wanted to get some other opinions as to the tax treatment before panicking them.

 

Thanks

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20th Nov 2017 15:36

I think it's a capital "receipt", because it's not actually a receipt at all. It represents a part of the original acquisition cost that has never, as a matter of fact, been paid by the individual.

According to SAIM2330 says that there's an extensive body of case law on the issue.

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to Portia Nina Levin
20th Nov 2017 15:49

Thanks Portia

Is the above reference correct? I went to that manual and it takes me to guidance on interest included in personal injury claims: https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/s...

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to KevinMcC
20th Nov 2017 16:12

Oops. I meant SAIM2230, which is referring to discounts, and saying that there is a body of case law on when they are capital in nature, which I imagine might help your arguments.

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By Ruddles
to Portia Nina Levin
20th Nov 2017 17:04

I don't agree that it's part of the acquisition cost. Presumably the previous owner is happy that he received payment in full. It follows that someone must have paid for it in full. That someone is the client, using monies borrowed from the bank. The asset is therefore his - subject to the rights of the bank to take it off him if he defaults on the loan repayments.

However, I'm in agreement that the 'receipt' should be treated simply as a reduction in the amount payable to the bank.

I prefer to refer to BIM, although it's far from conclusive. It clearly states that an unpaid trade debt should be written back to the P&L for tax purposes, the rationale being that it is an amount that has (presumably) been previously deducted for tax purposes. By implication (or is it inference?) there is no need to recognise a taxable credit in respect of something on which tax relief was not claimed in the first place.

Nevertheless, I would advise a sole trader against drawing up a balance sheet in these circumstances.

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to Ruddles
20th Nov 2017 17:09

I accept your point.

Mine was simply that, whilst the previous owner has received payment, the current owner has never actually borne the cost, and the amount now potentially being written off, representing, as it does, the amount not so borne, it cannot be regarded as being revenue in nature.

Equally, my reference to SAIM2230 was to support the "receipt" being treated as capital. An effective discount on a debt on a security, seeming to me to be a more appropriate parallel,in such circumstances, than an unpaid trade debt.

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