The loan relationship rules in a nutshell
Most forms of corporate debt held by companies are dealt with under the loan relationship rules. Primarily, the loan relationship regime governs the tax treatment of income and expenses from transactions that arise from the lending of money. However, it can also apply more broadly to other types of money debt that do not involve the lending of money (such as interest on trading debts).
This overview gives brief details of the operation of the loan relationship regime.
What is a loan relationship?
A loan relationship arises where a company:
- stands in the position of debtor or creditor in relation to a ‘money debt’, and
- that debt arises from a transaction for the lending of money
The loan relationships rules extend to cases where, although there has been no lending of money, an instrument has been issued representing the rights of the creditor in respect of a money debt (ie a security is issued). An example would be loan notes.
What is a money debt?
A money debt is a debt that may be settled by the payment of money or transferring the rights to settlement of another money debt or the issue or transfer of any share in any company.
As long as it is possible for the debt to be settled in money, then it is a money debt. This is true even if that possibility only existed for a short time or where the lender will also accept another form of repayment.
There are also certain transactions which are deemed to be loan relationships and therefore brought within the scope of the rules. The most common of these measures in a day-to-day commercial context are the rules in governing relevant non-lending relationships. These are money debts which while they do not arise from the lending of money frequently give rise to amounts such as interest or foreign exchange movements. Common examples include trading debts or outstanding rent and management expenses.
How is a loan relationship profit or loss calculated?
The amounts that are to be brought into account as loan relationship credits and debits for any accounting period are, as a general rule, the amounts that are recognised in determining a company’s profit or loss under generally accepted accounting practice (either UK or international accounting standards).
There are, however, a number of circumstances where the tax rules depart from this basis and where specific statutory rules override the accounting treatment. For example, special rules are triggered where the debtor and creditor parties to a loan relationship are connected in some way (see below).
The tax treatment of loan relationships differs slightly depending on whether the loan relationship is for trading or non-trading purposes. If the loan was for trade purposes, any associated income and expenses are included in the calculation of trading profits. A loan will have a trade purpose if the funds are used to generate income which is taxed as trading profits (for example, it was used to purchase stock).
However, if the loan relationship arose for non-trade purposes, the income and expenses on these non-trade loans are pooled together and included as a non-trade loan relationship profit or deficit for the period.
Are there special rules for loan relationships between connected companies?
There are specific rules that apply where debtor and creditor companies in relation to the loan are connected. The main consequence of being connected is that relief is denied for any debits in respect of impairment losses and releases. Similarly, any credits from the release are treated as non-taxable. In effect, the release is tax neutral for connected parties.
What does connected mean for loan relationship purposes?
Connection for these purposes means that one company controls another or both are under the control of a third person. It should be noted that if the parties are connected at any time in an accounting period, they are held to be connected for the whole of that period.
Control for these purposes requires the power of a person to secure that the affairs of a company are conducted in accordance with their wishes and is normally indicated where one party hold at least 51% of the ordinary share capital of the other.
Are there loan relationship anti-avoidance rules?
Relief is restricted where a loan is entered into for what is referred to as an ‘unallowable purpose’. Essentially, this rule is triggered when a company's underlying rationale for entering into (or, as the case may be, remaining a party to) a financing transaction includes a non-commercial or non-business justification.
Two particular types are specifically prevented from being a business or commercial purpose of a company. Broadly, these are where the loan relates to company activities which are not within the charge to corporation tax, or where one of the purposes of the loan is tax avoidance.
Other forms of anti-avoidance can apply to loan relationships including where the transaction is not at arm’s length or where it involves imported losses or disguised interest.