Ken Moody considers the consequences under the loan relationship rules where a debtor relationship is released and the debtor is not subject to formal insolvency proceedings.
Where a company borrows money for the purposes of its business, it enters into a debtor loan relationship with the lender. If the company carries on a trade, any credits or debits in respect of the relationship are treated as receipts or expenses of the trade; otherwise, they are treated as non-trading credits or debits.
In practice, it usually makes little odds, except that there are specific rules under which relief is allowed for non-trading deficits. But either way, credits and debits arising under the relationship will be taxable or allowable for corporation tax purposes.
Debt releases
In normal circumstances, one would not expect to see a credit under a debtor loan relationship. In fact, this is only likely to arise if the loan were released in whole or in part. Again, in normal circumstances, this is only likely to arise if the debtor is in financial difficulties and the creditor agrees to write off part of the debt in the hope of recovering the rest.
Clearly, if any credit to the debtor company’s profit and loss account is liable to corporation tax, this will exacerbate its financial problems. The legislation avoids this by providing (at CTA 2009, s 322) that credits need not be brought into account in any of five cases (A-E in the legislation).
A basic requirement is that any release takes place in an accounting period where an ‘amortised cost’ basis of accounting is used, where the loan asset or liability is accounted for at cost adjusted for amortisation of any discount or premium (unusually) and any impairment.
The five cases
Case A – the release is part of a statutory insolvency arrangement, such as a company voluntary arrangement (see CTA 2009, s 1319).
Case B – the release is the basis of a debt-for-equity swap.
Case C – the debtor company is in insolvent liquidation, administration or receivership, and the creditor company is not a connected company.
Case D – broadly refers to certain procedures under the Banking Act 2009.
Case E – applies where there is a material risk that within the next 12 months, the company will be ‘unable to pay its debts’ (and the release is not a ‘deemed release’ (see CTA 2009, s 358(3)).
A company is unable to pay its debts in two alternative circumstances:
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it is unable to pay its debts as they fall due; or
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the value of its assets is less than the amount of its liabilities taking account of its contingent and prospective liabilities.
The phrase ‘unable to pay its debts’ is based on the Insolvency Act 1986, s 123 definition, referring to the evidence a creditor would need to present to a court in winding up proceedings.
For Case E to apply, there must be a real prospect of insolvency, as an insolvency court would understand it, within the next 12 months (see HMRC’s Corporate Finance manual at CFM33000). If reliance were to be placed on Case E, it may be advisable to take advice from an insolvency practitioner on whether the company is unable to pay its debts by reference to either (a) or (b) and the relevant insolvency law and practice.
Practical tip
Case E may assist in facilitating a ‘corporate rescue’ where a company is in financial distress but the business is viable. Indeed, if the creditor is a financial institution, it is not likely to agree to the release unless it considers that the debtor company will otherwise become insolvent. At CFM33192, HMRC states: “… a release in such circumstances will normally be sufficient evidence that the debtor is in genuine financial distress.”
