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Is tax relief a guarantee?

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Many owner managers provide guarantees to lending institutions for loans made to their companies but is tax relief available when that guarantee has to be honoured? A recent case demonstrates how tricky this question can be because of how tax rules are structured.

The taxpayer was a director of a property trading company and made payments under a guarantee given to the bank which had lent money to the company. Immediately prior to the Tribunal hearing, HMRC accepted the company was carrying on a trade. This is critical to obtain tax relief when loans become irrecoverable and guarantees have to be paid out.

The bank made loans to the company and the taxpayer was a guarantor of the loans. The loans were used to acquire two flats, each with a view to selling them on at a profit. The interest payments exceeded the rents received for every accounting period that the company existed and the shortfall was made up by the taxpayer. The majority of the interest payments were paid directly by the taxpayer to the bank and the amounts owed by the company to the taxpayer resulted in credits to his loan account.

In June 1994 the bank demanded immediate payment of the outstanding balance. The letter stated that:
‘… the event of our not receiving such repayment we shall proceed to exercise our rights under any security we may hold.’ The company was dissolved in March 1995. The taxpayer claimed loss relief for the loan and interest payments he had to make under the guarantee. HMRC argued that loss relief was not available at all because the loan was irrecoverable at the outset and so did not become irrecoverable. They also said there was no evidence that repayment was demanded by the bank under the guarantee which is essential to get tax relief.
The taxpayer argued that the bank loans were not irrecoverable from the outset and the payments had been made under the guarantee.

The decision

The Tribunal held that the documentary evidence available showed that a commercial lender had been prepared to lend money to a company which had bought two properties, which did not indicate that outstanding amounts on those loans would be irrecoverable at the outset:

‘In our view it was only when it became clear the property would be disposed of at a loss that sums paid in respect of interest on the loans would be known to be irrecoverable. We therefore do not agree with HMRC’s submission that the loss relief claim should be denied on the grounds that the outstanding amount had not become irrecoverable.’ As to whether the payments had been made under the guarantee, the Tribunal held:

‘We think it is for the appellant to establish that the payments were made under the guarantee but there is inadequate evidence before us to reach that conclusion. We accept the appellant may genuinely have been motivated to make the payment in the knowledge that if there was a shortfall he would be pursued for it under the guarantee but this cannot answer the test posed in the legislation which we think is an objective one.’

Whilst the position as to who was obliged to pay what to who was not clear, the Tribunal accepted that the payments amounted to there being a loan between the taxpayer and the company which was reflected in the directors loan account with the company. The taxpayer was therefore entitled to his claim for the outstanding amount of the loans he made to the company.

What relief then for the allowable loss?

Once established such losses can however only be used against capital gains and not income. This is in contrast to losses on the disposal of shares where an individual has subscribed for the shares in a qualifying trading company. Such losses on shares can instead be relieved against income (subject to a maximum from 2013/14 depending on individual circumstances) which generally means relief is available earlier and often at a higher rate of tax.

How we can help?

You can see that the way in which capital and financing structures operate can affect the tax relief you may obtain so please contact us to review what is most suitable for your circumstances.

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