There are a number of issues to be determined in this situation:
- Is there an allowable loss at all?
- Is it a connected party transaction
- Has there been a disposal?
- Is any allowable loss ‘clogged’?
To begin with, relief is only due if the loan has become irrecoverable. This doesn’t mean merely that the borrower can’t repay the loan at the date you make the claim. You have to show that there is no reasonable prospect of the loan ever being repaid. If the borrowing company continues to trade, this test is unlikely to be satisfied.
The loan must also have become irrecoverable. Relief won’t be due if the loan was irrecoverable when it was made. If you make a claim shortly after making the loan, this may cast doubt on whether the loan was ever recoverable in the first place. The loan must not have become irrecoverable as a result of the terms of the loan or some act or omission by the lender.
In order to satisfy HMRC that this was a genuine loan, it may be necessary to review the loan agreement. If we assume that the loan would be accepted as a capital loss we now consider the question of whether or not this would be considered to be a clogged loss.
The relevant legislation is TCGA1992/S18(1) which applies where “a person acquires an asset and the person making the disposal is connected with him.”
TCGA/S18(3) then limits the way in which a loss can be used if it arises from a disposal to a connected person. Such a loss is said to be ‘clogged’.
The basic rule is that such a loss can only be set off against gains which:
- arise from other disposals (in the same or a later year) to that same person; and
- arise at a time when the persons concerned are still connected.
The definition of “connected” for this purpose is given in TCGA1992/S286(6), which provides that “a company is connected with another person if that person has control of it or if that person or persons connected with that person together have control of it.”
In respect of the question we are considering today, clearly, this is a connected party transaction. The director who gave the loan has a controlling interest in the company because of his majority shareholding. Therefore on the facts presented it would appear to be a clogged loss.
However, we need to carefully consider TCGA 1992/S253. HMRC have helpfully produced some commentary in the Capital Gains Manual at CG65910. This makes clear that that where a loan has become irrecoverable, whilst S253 deems an allowable loss to accrue at the time of the claim, there has been no actual disposal of a chargeable asset.
To go back to S18(3) as discussed above, losses are only clogged if there has been a disposal to a connected person – but an irrecoverable loan does not involve a disposal at all and consequently, the loss cannot be clogged. Normal relief provisions will therefore apply.
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