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Corporate tax: You are not a loan

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Andy Keates examines whether a strange and ill-defined financial arrangement between two companies was a loan relationship, and if the director of one company received a beneficial loan in the process.

15th Sep 2021
Tax writer
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WT Banks & Co Farming Ltd (WTB) was a close company which owned land and ran a farming business. Stuart Banks was a director and major shareholder.

He also owned 50% of the share capital of Solar Energy Parks Ltd (SEL). The remaining 50% of SEL was owned by its other director, Eann Smith.

In his evidence to the FTT Banks explained his motivation for setting up SEL:

The industry norm for land rented out as a solar farm was some £1,500 per acre for 20 to 25 years. 200 acres were normally needed for a solar farm and a guaranteed income of £300k [per annum] for 25 years was an attractive return.”

This compared with around £80 per acre for farming. Furthermore, the planning permission granted for commercial use as a solar farm would make it easier to get planning permission for lucrative residential or commercial development at the end of the lease.

Smith, an old friend, was known to have some expertise in planning matters, so Banks persuaded him to enter a joint venture, and SEL was formed in 2014.

The set-up

According to Banks, the business model was:

  • Smith would use his skills to obtain planning permission on behalf of landowners, while Banks would provide funding;
  • Banks would use his farming connections to bring landowners to SEL, in addition to supplying WTB as the company’s first client;
  • Once planning permission was obtained, the clients would grant a 25 year lease to SEL while retaining the grazing rights around the solar panels;
  • When a solar farm had been completed, SEL’s leasehold interest would be sold (presumably at a premium) to Scottish Power or some other generating company.

There was little or no documentation of this plan: no cash flow forecasts and no business plan were ever drawn up. Banks admitted he had agreed to a completely open ended funding commitment, as his eye was on the potential future rewards.

Finance

This emphasis on the future rewards (“the big money was in the rental which WTB would receive under the lease and in the reversionary interest in the site which could be worth millions”) largely explains the casual attitude Banks had towards the structure of the loans to SEL – the interest return was a relatively minor and insignificant element of the deal.

Banks’ accountants (Cobhams) advised him to utilise a direct loan between the two companies; the alternative, a loan from WTB to Banks which he then invested in SEL, would incur a tax charge under the “loans to participators” rules.

Between 26 March 2014 and 30 June 2015, WTB paid a total of £365,000 to SEL, together with £88,191 in planning fees paid by WTB on SEL’s behalf to local authorities. In the year to 30 June 2016 it paid £110,000 directly to SEL and disbursed £22,383 on SEL’s behalf.

WTB’s bookkeeper gave evidence that, in the absence of other information, she initially posted all the SEL payments to Banks’ director’s loan account. Only in June 2015 was she informed of the true nature of the payments, and transferred them to a separate SEL loan account.

Despite the initial debit of these significant amounts, Banks’ loan account remained in credit at least until December 2014. Cobhams confirmed that the reposting to an SEL account was in accordance with their earlier advice, and definitely was “not made simply to avoid a debit balance on Mr Banks’ loan account”.

Collapse

In May 2015 Smith resigned as a director of SEL, being replaced by his wife, Ms Ditchfield. This coincided with a souring of the relationship between the two men, alongside the growing realisation that planning permission for the WTB land was unlikely to be granted – following the failure of a planning appeal, SEL was struck off in June 2016.

Following the collapse of SEL, the WTB accounts for year to 30 June 2016 “recognised a deduction under the loan relationship provisions from its taxable profits as the result of making a bad debt provision in respect of a loan made to SEP, being the amount of the sums paid to or for the benefit of SEP since 2014”.

Dispute

HMRC’s view was that WTB had lent money to Banks (and had otherwise expended money which was owed to it by Banks) who then invested it in SEL. The corporation tax deduction was disallowed, and a charge under the loans to participators provisions was raised. WTB appealed to the FTT (TC08124).

Judgment: Loan Relationship

Judge Hellier noted that the criteria which would need to be satisfied by WTB if it were to satisfy the loan relationship definition in CTA 2009, s 302 were:

  • it was a debtor in respect of a debt due from SEP,
  • that debt fell to be settled by the payment of money, and
  • that debt arose from a transaction for the lending of money.

He concluded that, while “there was some sort of informal agreement between Mr Smith and Mr Banks that if planning permission were obtained on WTB’s land, WTB would get a proper return from the land and the monies put into the venture. I am unable to conclude that there was any form of legal obligation or contract under which SEP was bound to repay those monies to WTB with or without interest”.

The judge noted; “the absence of any – even back of the envelope – business plan or budget suggests to me a vague agreement between friends in which the detail was to be left for later”.

The judge upheld HMRC’s disallowance of the loan relationship deduction.

Judgment: Loans to participators

It is clear that WTB was a close company, and that Banks was a participator. If it transpired that Banks had incurred a debt to WTB as a result of any of the payments it made, then a charge under CTA 2010 s 455(2) would be due.

In the judgment of the FTT, Banks did not become indebted to WTB by virtue of the payments made to or on behalf of SEL. Accordingly, there was no loan to him, and the charge under CTA 2010 s455 was dismissed.

A step too far

It seems clear that the entire arrangement was a casual and ill-conceived idea between two friends, which was awkwardly shoehorned into a deal between two companies, without so much as a scrap of paper to indicate that either company was committed to it.

HMRC’s approach went a little too far. Denying corporation tax relief to WTB for some £585,000 which it poured into this venture was fair enough, and should have sufficed. Trying also to depict the expenditure as a loan to Banks seems like greed.

Replies (4)

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By Justin Bryant
15th Sep 2021 17:06

Compare and contrast with this recent interesting case, where an oral loan agreement was for some reason accepted by HMRC as an agreed fact.

https://www.bailii.org/uk/cases/UKFTT/TC/2021/TC08261.pdf

The NTLRD was disallowed in any event. If the taxpayer had succeeded it would have been odd to put it mildly, as UK Ltds could have been very easily used as tax-free property investment vehicles for non-UK residents (and there is no UK WHT on loan premiums).

I'm not sure if the distribution analysis in para 123 was correct, based on the distribution comments at para 77 here: https://www.bailii.org/uk/cases/UKFTT/TC/2021/TC08246.pdf

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Replying to Justin Bryant:
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By Justin Bryant
07th Oct 2021 13:15

I'm not sure if this TJ analysis is quite right re the above NTLRD case, but it's interesting nonetheless.
https://www.taxjournal.com/articles/tax-net-accounting

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By Paul Crowley
16th Sep 2021 20:35

What a catastophe
Zero planning
HMRC correct to disallow
Also correct to stab in the other direction as tribunals do sometimes produce inappropriate decisions

But that is an opinion of a taxpayer thay has never engaged in tax avoision, and is pi55ed off with how often those who do get away with it

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paddle steamer
By DJKL
20th Sep 2021 16:40

[***] poor planning means everybody hurts, if you feel like you're alone
no, no, no, you are not alone.

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