Loan Relationships

By | 26 November 2011

The loan relationships provisions for companies have been around since 1996, and it is fair to say that the legislation overall is complex. However, it is not normally difficult to identify a loan relationship for these purposes, although a recent case indicates that even this task may not be without its problems.

The loan relationship legislation in FA 1996 was rewritten and is now contained in CTA 2009. It states that a company has a ‘loan relationship’ for corporation tax purposes if it is either a debtor or a creditor in respect of a money debt, and the debt arises from a transaction for the lending of money (CTA 2009, s 302). HMRC guidance points out that not all money debts arise from the lending of money, such as trade debts (CFM31010). The same applies to directors’ loan accounts consisting only of undrawn or overdrawn remuneration etc.

In the context of inter-company accounts, HMRC states that balances on such accounts may arise from the lending of money where one group member has borrowed from another (CFM31040). Money debts not arising from the lending of money are brought into the loan relationship regime (as ‘relevant non-lending relationships’), by treating them as such (CTA 2009, Pt 6). 

The term ‘transaction for the lending of money’ seems straightforward enough on the face of it. However, in MJP Media Services Ltd v CRC [2011] UKUT 100 (TCC), the taxpayer company (MJP) was a wholly-owned subsidiary of company C. Company C in turn was a wholly-owned subsidiary of company A. A series of inter-company transactions took place between MJP and company A. A signed agreement stated that MJP had loaned a sum of money to company A, and provided for interest to be charged. A deed of waiver was subsequently signed, in which MJP agreed to waive most of the outstanding sum. MJP claimed a deduction in its corporation tax computation in respect of the waived amount. HM Revenue and Customs (HMRC) disallowed the deduction claimed in respect of the loan relationship debit. MJP appealed.

Lending of money

The First-tier tribunal ([2010] UKPTT 298 (TC)) had to consider whether the inter-company debt arose from ‘transactions for the lending of money’ and was thus within the definition of loan relationship. The tribunal decided against the taxpayer company, which subsequently appealed. The Upper Tribunal noted that the First-tier tribunal made the point that MJP had only disclosed four bank statements, which showed only a few of the relevant transactions. The witnesses had given “unsatisfactory explanations” for the failure to produce bank statements for the other transactions, and did not have first- hand knowledge of the transactions.

Counsel for MJP defended the company’s inability to produce the necessary bank statements (notwithstanding the requirement to retain them for six years for VAT purposes), the witnesses’ lack of first-hand knowledge of the relevant transactions, the accounting documents (which the First-tier tribunal had regarded as incomplete evidence), and an inability to explain certain matters. However, the Upper Tribunal rejected those arguments.

To prevail on the appeal, MJP needed to succeed in its arguments on all (four) transactions. The Upper Tribunal considered two of them, and agreed with the First-tier tribunal that the first transaction was not, on the balance of probabilities, a cash payment. The tribunal was not obliged to explain the transaction and why the same sum subsequently turned up in the books of company A. With regard to the second transaction, MJP had argued that company A had repaid £6.1 million to company C, that company C had repaid the same sum to MJP, and that MJP had paid company A the same sum. However, it was unable to explain why the transactions took place or how the transfers had been made, or show that cash payments had been made as opposed to transfers by book entry. It was held that the First-tier tribunal had been entitled to conclude that MJP had taken over company A’s debt to company C, in exchange for cancelling company C’s own debt, and that the transaction had been by book entry.

The Upper Tribunal also dismissed MJP’s argument that even if payments were made by MJP to third parties on behalf of company A, that was sufficient to amount to “transactions for the lending of money”. The company’s appeal was dismissed.

The first hurdle

In practice, it is perhaps understandable to focus on how a loan relationship should be treated for tax purposes, particularly in view of the complex legislation in this area. However, the MJP case is a reminder of the importance of ensuring that a transaction falls within the statutory definition of a loan relationship to begin with.

The case is perhaps unusual, in the sense that the taxpayer company could not produce banks statements for all relevant transactions, or provide other satisfactory evidence or explanations to support its arguments. However, it does emphasise the general need to retain records and documentary evidence of transactions, not least because of a statutory requirement to do so in many cases (e.g. TMA 1970, s 12B for individuals, or FA 1998, Sch 18, para 21 for companies), and also where such evidence is important to the taxpayer’s claims or arguments.

The above article is reproduced from ‘Practice Update’ (November / December 2011), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.