That’s A Relief! Debts And CGT

 

The ground rules regarding the capital gains tax (CGT) treatment of debt are given by TCGA 1992, s 251. The disposal of a debt by the original creditor cannot give rise to a chargeable gain or an allowable loss, the exception being a ‘debt on a security’ (see below). The satisfaction (i.e. repayment) of a debt or part of it is regarded as a disposal or part disposal of the debt. A debt may legally be transferred by the creditor to another party, though this is unusual except perhaps as some sort of financial restructuring. 

 

At any rate, it follows that if a debt is acquired from the original creditor it becomes a chargeable asset unless the assignee is carrying on banking or another financial trade. However, if the assignee and the original creditor are ‘connected persons’ for CGT purposes, a loss on disposal by the assignee is not an allowable loss. 

 

Of course, corporate debt is covered by the loan relationship rules (in CTA 2009, Pts 5-7). A director’s loan account (DLA), for example, may be a loan relationship as far as the company is concerned, but not as regards the director. If the DLA is in credit and the company is wound up or the debt is written off, there is no satisfaction of the debt and so no disposal as such. In any event, as the director is the original creditor no allowable loss arises. 

 

However, a loss on a loan to a (corporate or unincorporated) trader for money which is used in the borrower’s trade may be relieved under TCGA 1992, s 253 (‘Relief for loans to traders’). On a claim under s 253, the creditor is treated as if an allowable loss had accrued. In theory, s 253 applies whether the creditor is an individual or a company, but relief is excluded where the write-off, etc., is brought into account as a loan relationship debit.

 

As noted, s 251 makes an exception from the general rule in the case of a ‘debt on a security’ as defined by TCGA 1992, s 132, which is part of the CGT rules pertaining to company reorganisations of capital (including company reconstructions) and, in short, refers to ‘loan stock or similar security, whether secured or unsecured’. A debt does not therefore fall within the definition simply because it is secured on company property. 

 

The point is relevant because, in some circumstances, it may be preferable to ensure that a debt is not within the definition, as explained shortly. It has to be said that this is a difficult subject (as acknowledged by the House of Lords in W T Ramsay Ltd v CIR 54 TC 101). Suffice it to say for present purposes that a debt on a security must have some characteristic of marketability enabling it to be realised or dealt with at a profit. On the sale of a company, part of the purchase price may consist of loan notes. Is that a debt on a security? If the loan notes were marketable the answer may be ‘yes’, but a debenture issued as part of a company reorganisation or reconstruction may be treated as a debt on a security anyway (by s 251(6)). 

 

Moreover, loan notes will usually be ‘qualifying corporate bonds’ (QCBs) for the purposes of TCGA 1992, s 116. This affects the calculation of the gain on the sale of the company, the CGT treatment of the loan notes themselves, and the availability of CGT entrepreneurs’ relief. 

 

If the purchase price of an asset is payable by instalments, no allowance is made initially for the possibility of non-payment of any of the instalments (by virtue of TCGA 1992, s 48). The whole gain is therefore taxable ‘up-front’, but should any of the deferred consideration prove irrecoverable, a claim may be made (under s 48(1)) to adjust the gain on disposal accordingly. The time limit for making such a claim runs from the time when the balance of the proceeds becomes irrecoverable (see HMRC’s Capital Gains manual at CG14933) to which the general time limit for claim applies, i.e. four years from the end of the year of assessment to which the claim relates. 

 

If a company sale involves payment of the sale price by instalments, the usual course would be to issue loan notes for the deferred consideration. However, loan notes will usually be QCBs, which are not chargeable assets themselves, and so the part of the gain on sale of the shares deferred by the loan notes falls into charge as and when the loan notes are disposed of. The problems this creates are:

 

The consequences of b) may be mitigated by an election (under TCGA 1992, s 169R) to pay CGT ‘up-front’ on the whole gain on disposal of the shares (i.e. effectively dis-applying s 116). However, that still leaves the potential problem that if the loan notes go bad CGT will have been paid, albeit at 10%, on monies never received. Sometimes, if there are doubts as to whether the loan notes will be honoured, it may be preferable to structure the deferred consideration as a simple debt, so as to be able to make a claim under s 48, if necessary.

 

At this point, we are talking basically about company sales which go wrong. This happened to a client of mine recently. The company had been making losses and a sale was recognised to be the best of a bad job, and that the vendors might be lucky to receive all their money. We therefore structured the deferred consideration as a simple debt, so that a claim under s 48 would be possible in that event.

 

However, the debt was secured on company property and the liquidator offered the vendors the property in exchange for the write-off of the debt, so that the company could then be wound up. Let’s say the debt is £1 million and the property is worth £500,000. TCGA 1992, s 251(3) provides that where property is accepted by a creditor in satisfaction of a debt (or part of it) the property is treated as transferred for a consideration not greater than its market value. However, any gain on the subsequent disposal of the property is reduced ‘so as not to exceed the chargeable gain which would have accrued if he [the creditor] had acquired the property for a consideration equal to the debt or that part of it’. 

 

In my client’s case, there is a possibility of planning permission being granted for residential development. If the property is sold for development in a couple of years for, say, £750,000, the effect of s 251(3) is that the property is treated as having been acquired for £750,000, so there is no capital gain on disposal. Obviously, if the property is sold for £1,250,000, this exceeds the debt written-off and a gain of £250,000 would arise because the maximum reduction of the gain under s.251(3) is the total amount of the debt of £1 million.

 

The mechanics of the ‘exchange’, including the accounting treatment, also need to be carefully considered. 

 

• Where the sale of a company involves deferred consideration, the tax implications are complex: where the structure adopted aims to ensure that relief under TCGA 1992, s 48 might be available, it is vital not to create any debt instrument which might be deemed to be a debt on a security and also a QCB. Expert advice is therefore strongly recommended. 
• Where TCGA 1992, s 251(3) might apply, there are other tax issues which may be relevant, for example stamp duty land tax (or land and buildings transaction tax in Scotland) on the transfer of the property and, again, professional advice is recommended.