An article by Mark McLaughlin
The number of capital loss claims in respect of irrecoverable loans to businesses (or loan guarantee payments) has probably increased significantly during the economic downturn. Claiming relief seems straightforward enough on the face of it, but there are some potentially difficult obstacles to overcome.
For example, the relief applies to qualifying loans (TCGA 1992, s 253(1)). A 'qualifying loan is broadly a loan used for the borrower's trade, profession or vacation. This excludes money lending trades. In addition, the borrower must be UK resident. The debt must not be a 'debt on a security'. HMRC also state that the loan must be "in money" (CG65391).
In addition, the parties must not be connected as spouses, civil partners or group companies, when the loan was made or subsequently. For companies, relief is not available to the extent that a loan relationship debit is available to the claimant. In all cases, the loan must have been made after 11 April 1978.
The most difficult aspect when considering a relief claim is often to determine whether a loan is irrecoverable, and when it became so. The loan must have become irrecoverable at the time of the claim. It should be noted that the terms of the loan, or any arrangements of which the loan forms part, cannot make the loan irrecoverable for relief purposes. Nor can any act or omission by the lender (or guarantor, in the case of relief for guarantee payments).
HMRC consider that a loan is 'irrecoverable' if there was "...no reasonable prospect of recovery of the loan as at the date claimed". HMRC will look at the funds potentially available to the business for this purpose, and state that a relief claim cannot therefore be established simply by looking at the borrower's balance sheet (CG65950). In addition, HMRC guidance indicates that "exceptionally" there may be no reasonable prospect of recovering a loan even though the trader continues to trade. Unfortunately, that is a matter of opinion and judgement, which can lead to disputes between taxpayers and HMRC.
Care also needs to be taken to ensure that the loan has 'become' irrecoverable, and was not irrecoverable when the loan was made. If more than one loan has been made, the recoverability or otherwise of the loan will need to be considered at the time when each loan was made. If the later loans have been made after the date on which relief under s 253 has been claimed in respect of earlier loans, HMRC will normally resist s 253 claims on the later loans unless there was a "marked improvement" in the borrower's prospects after the time when the earlier were claimed to have become irrecoverable (CG65957).
Claims for relief
The relief for loans (or guarantees) to traders must be claimed. There is no standard form for claiming the relief, although HMRC Helpsheet 296 gives guidance to individuals on the tax return entries to be made. In addition, HMRC state: "In practice, any clear indication by the lender and his agent that relief is sought in respect of a specific recoverable amount should be accepted as a valid notice of claim" (CG65940).
No time limit is specified in s 253 for a claim in respect of irrecoverable loans. However, HMRC Helpsheet 296 states:
“After the loan has become irrecoverable there is no time limit in which to make the claim. The loss will arise:
• at the time you make the claim or, if you want,
• at an earlier time you specify when you make your claim that falls in either of the two previous tax years, provided all the necessary conditions for relief are satisfied at the date you make the claim and at the earlier time.”
Clawback of relief
If relief has been given in respect of a loan (or guarantee payment), to the extent that the outstanding amount is recovered by the same person, a chargeable gain is treated as accruing at that time. Similarly, if a payment made under guarantee is subsequently recovered, a chargeable gain arises (s 253(5), (6)). Recoveries may be made by the claimant or any other person under the claimant's direction (CG66062). For group companies, there are also provisions dealing with loans or guarantee payments recovered by another group member, which treat a chargeable gain as arising to that other group member (s 253(7), (8)).
As indicated above, a capital loss can also arise in respect of payments made under guarantee in respect of a qualifying loan. The relief is subject to similar conditions as for loans to traders (s 253(4)). The allowable loss is broadly the guarantee payment in respect of the irrecoverable amount, less any contribution payable by a co-guarantor in respect of that payment. Claims for relief must be made by the fifth anniversary of 31 January following the tax year in which the guarantee payment was made (CGT) or within six years after the end of the accounting period in which the payment was made (corporation tax) (s 253(4A)).
As with virtually all forms of tax relief, a number of conditions must be satisfied for claiming capital loss relief in respect of loans to traders. In addition, whilst HMRC's Capital Gains Manual does not carry the force of law, the guidance on relief for losses on loans to traders and for payments under a guarantee provides a useful insight into HMRC's approach when considering claims for relief.