Loss relief for loan guarantee is not certain
When a taxpayer pays up under the terms of loan guarantee they may be able to claim a capital loss, but only if all the conditions of TCGA 1992 s 253 are met, as illustrated by the different outcomes in the cases of Ron Dennis and Michael Hunt.
In broad terms, TCGA 1992 s 235 provides:
- If you lend money at arm’s length to a trader and the debt becomes irrecoverable, you have realised an allowable capital loss
- If you stand as guarantor to such a loan and have to make a payment to the lender in pursuit of that guarantee, that also becomes an allowable capital loss.
Ron Dennis case
In 1998, businessman and motor racing mogul Ron Dennis (TC06868) entered into a joint venture with a company (TAG), funding the JV company by a mix of ordinary voting shares, non-voting preference shares and loan capital.
Clause 10.3 of the joint venture agreement envisaged the situation where the JV company was wound up and the investors failed to get back their full investment so there was a shortfall. In such a situation, the total shortfall was to be apportioned in accordance with their respective voting entitlements and the parties undertook to make balancing payments between themselves to bring their share of the economic loss to that proportion.
The JV company went into members’ voluntary liquidation in 2005. Under clause 10.3, TAG made a claim against Dennis for £3m which was paid on 23 April 2007. Dennis claimed this as an allowable loss under TCGA 1992 s 253(4) and offset it against his other chargeable gains for 2007/08.
HMRC argued that most of Dennis’ loss related to his investment in ordinary and preference shares in the JV (for which he could not claim an allowable loss), rather than as a payment under a guarantee. HMRC was prepared to concede an allowable loss of £490,693.
Did a guarantee exist?
The case hinged on whether clause 10.3 of the joint venture agreement actually amounted to a loan guarantee. If did not, then no loss relief was available.
In legal terms, a guarantee is a specific form of indemnity: an arrangement whereby one person can look to another to satisfy their losses.
A guarantee consists of a written arrangement between three parties: the guarantor agrees to satisfy the principal’s financial obligation to the debtor.
It has two particular characteristics which come into play in this case:
- Co-extensiveness. There is no liability on the part of a guarantor if the underlying obligation is void or unenforceable, or if that obligation ceases to exist.
- The right of subrogation. A guarantor, once they have made payments under the guarantee, has a right to pursue the principal for their expenditure.
Dennis’ obligations under 10.3 only arose once the JV company’s obligations to TAG had ceased to be in any way enforceable.
“Since Mr Dennis could not make full payment under clause 10.3 until the last distribution in the company’s liquidation has been made, [he] could never have any meaningful right of subrogation against the company”.
The judge concluded that, while clause 10.3 was clearly a form of indemnity, it was not a guarantee.
Dennis lost his appeal. Arguably, he came off better than he might have feared, since HMRC had already conceded the £490,000 loss – which, since there was no loan guarantee, was not strictly due.
Michael Hunt case
In contrast to the Dennis case, Michael Hunt (TC07311) had made a payment under what everyone agreed was a valid loan guarantee. The question in this case concerned the trading status of the company which took the loan.
Hunt was a 22% shareholder in Altala Ltd, a company set up to establish a health lottery with the specific aim of supporting the NHS. He issued a guarantee, via a nominee company, for Altala’s £17,500,000 loan facility with Barclays Bank.
Following significant set-up activity, Altala failed to obtain a lottery manager operating licence from the Gambling Commission. In 2009, Altala went into administration and sold its assets to Health Lottery Limited, which successfully launched the Health Lottery.
By this stage, Barclays had recalled its debt and Hunt’s nominee company had paid the £17,500,000. He claimed the allowable loss under TCGA 1992 s 253(4).
HMRC agreed that “Hunt made a payment, through his nominee … of £17,602,601 pursuant to a guarantee of a loan … which has become irrecoverable … and that the loan was used by Altala for the purposes of setting up a trade”.
Where HMRC disagreed was whether Altala Ltd had actually traded. If there had been no trade, there could be no relief.
Was Altala trading?
HMRC pointed to the fact that no Gambling Commission licence had been obtained at the time of liquidation and therefore the company could not legally trade as a lottery manager.
The judge looked at the activities which had been undertaken in anticipation of obtaining a licence. These included:
- Production of play cards
- Agreements with payment handlers and retailers
- Advertising and marketing
- Establishing a customer contact centre and IT infrastructure
- Acquisition of lottery ball machines
- Taking out prize insurance
It was significant that Altala’s successors used most of Altala’s groundwork and assets for their successful launch of the Health Lottery: Altala had put everything in place bar the licence.
The judge referred to the leading case (Mansell), which suggests that:
“Trade commences when the taxpayer … begins operational activities - and by operational activities I mean dealings with third parties immediately and directly related to the supplies to be made which it is hoped will give rise to the expected profits, and which involve the trader putting money at risk”.
On this basis, the judge considered that “Altala did engage in operational activities in which it incurred a financial risk.”
The company had done enough to be treated as trading, and Hunt’s appeal was allowed in full.