Loan Relationships & Corporation Tax
A ‘Loan relationship’ is a term which encompasses an extremely wide area of financial arrangements from a straight forward loan to complicated financial activity supporting trading between associated corporate bodies.
Money does not have to physically change hands and the loan may be accomplished by, for example, a ‘loan note’ issued by a company for the purchase of an asset.
Loan relationship rules are extremely complicated when dealing with the taxation of income deriving from such activity between a company and another party, which may or may not be another company.
Two essential elements must be present for a loan relationship to exist being:
- a money debt which arises from
- a money lending transaction.
Profits and losses arising from loan relationships are treated as follows:
- when in the course of a company’s trade – in the calculation of trading income
- when not in the course of its trade, as non-trading credits or debits.
Companies subject to UK Corporation Tax are taxed on income, taking into account amongst other things credit and debit payments.
Payment of interest is the most common form of income to be brought into account under the loan relationship regime.
Tim Thompson of KANGS provides general comments on the liability to Corporation Tax for interest arising from loan relationships.
What is interest?
There is no statutory definition of interest for tax purposes.
However, there exists considerable case law with the most recognised definition having been made by Rowlatt J in Bennett v Ogston where he described interest as ‘payment by time for the use of money.’
For interest to arise, there must be a principal sum which generally arises by virtue of:
- a sum of money advanced,
- debt which has arisen,
- an amount withheld,
- an amount lost.
This was supported in Westminster Bank v Riches in which it was stated:
‘… the essence of interest is that it is a payment that becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have if he had had the use of the money, or conversely the loss he suffered because he had not had that use.’
In Re Euro Hotel (Belgravia) Ltd, Mr Justice Megarry stated "there must be a sum of money by reference to which the payment which is said to be interest is ascertained."
Wigmore v Thomas Summerson indicates that true interest accrues from day to day or at periodic intervals.
Seaham Harbour Company v Crook provides that a voluntary or gratuitous payment cannot be interest. This is so even if the payment is paid in lieu of or is equivalent to interest.
The Nature of Loan Relationships
Debtor relationships
A company will have a trading loan relationship as a borrower, if, during its company trade, it entered into a loan agreement for the purposes of, for example, the expansion of such trade or the purchase of equipment essential for such trade.
Creditor relationships
A company will only have a trading loan relationship as a lender if, in the course of essential trading activity, it is party to a creditor relationship, for example, a bank, financial trader or insurer.
Identifying Liability for Tax | Loan Relationships
The way in which potential tax liability is handled depends on whether there exists a trade or non-trade relationship, as previously mentioned.
For the relevant accounting period, where the credits arising from loan relationships exceed debits from those sources, the excess is a loan relationship credit which attracts Corporation Tax.
Conversely, where the debits exceed the credits, a loan relationship deficit arises which will be set against other profits which may arise.
Such credits and debits are identified by calculating:
- all profits arising from the company’s loan relationships and associated transactions,
- interest received,
- expenses and set offs,
- exchange gains and losses.
Who Can I Contact for Help?
When any form of commercial dispute arises concerning a loan agreement, whether relating to tax on interest arising or any other issue, it is essential that expert legal advice is sought.
HMRC frequently investigates the operation of loan agreements, or arrangements purporting to be so and will not hesitate to take action to recover any amounts of tax which it considers having been underpaid.
Our Team will support you throughout the entirety of any HMRC investigation or proceedings, seeking to achieve the most satisfactory outcome available as quickly and economically as possible.
If we can be of assistance, please do not hesitate to contact our Team using the details below:
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through live conferencing or telephone.
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