Tribunal clarifies scope of ‘imported loss’ rule
Loan relationship debits recognised after company migrates to the UK found to be non-deductible
Loan relationship debits recognised after company migrates to the UK found to be
The idea that a jurisdiction might wish to tax unrealised gains on assets and liabilities moving out of its tax net is a familiar one. Conceptually similar, but less prominent in practice, is the idea that a jurisdiction might also wish to deny relief for unrealised losses on assets and liabilities moving into its tax net.
The UK rule which seeks to give effect to this latter goal in relation to assets or liabilities which are loan relationships is s327 Corporation Tax Act (CTA) 2009. This broadly denies relief for any ‘loss’ on a loan relationship that is ‘referable’ to a time when that relationship was not subject to UK tax (essentially a time at which the relevant company would not be chargeable to UK corporation tax on profits arising from the relationship). The recent decision of the First-tier Tribunal in UK Care No 1 Ltd v HMRC [2024] UKFTT 542 (TC) is the first case to consider this rule and sheds important light on its scope. As such it will be required reading for anybody considering the implications of transactions (most commonly, company migrations) by which a company brings its loan relationships within the scope of UK tax.
The case concerned a Guernsey loan note issuer which was part of a securitisation structure providing financing to a UK care home business. The business wished to dispose of some of the assets acting as security, and in order to facilitate this needed to redeem the loan notes. This was achieved by migrating the issuer to the UK and providing it with sufficient equity funding to enable it to carry out the redemption.
The terms of the loan notes included a ‘Spens’ (or ‘make whole’) clause which permitted early redemption at a premium. That premium effectively comprised two elements:
- A ‘compensatory’ element corresponding to the difference between the market and face value of the notes, effectively compensating investors for the loss of future cashflows; and
- A ‘penalty’ element intended to disincentivise early redemption.
As a consequence of the early redemption, the company also recognised the unamortised portion of a discount on the original issue of the loan notes and of the initial transaction costs incurred when the structure was established.
HMRC successfully argued that (with the exception of the ‘penalty’ element of the early redemption premium) these costs all fell to be disallowed as ‘referable’ to the pre-migration period.
The key question for the Tribunal was what it meant for costs to be ‘referable’ to that period - a concept not further defined in the legislation. Underpinning its response to that question was the Tribunal’s view that (at least on the facts of this case) what mattered was “whether the loss (or the relevant part) would have arisen but for an expense which was incurred during the pre-migration period or some change or event occurring after the loan relationship came into existence but during the pre-migration period”.
On that approach the disputed amounts were clearly referable to the pre-migration period because:
- The ‘compensatory’ element of the redemption payment was wholly attributable to changes in market conditions between the inception of the loan and the company’s migration (as could be seen from the fact that if these had not changed, then there would be no divergence between the face value and market value of the notes and hence no compensatory element to pay), with essentially the same reasoning applying to the unamortised portion of the discount on issue; and
- Notwithstanding the fact that they were being recognised for accounting purposes over the life of the loan notes, the initial transaction costs had clearly been incurred pre-migration.
Whilst the particular facts of the case are slightly unusual, it will be important to take account of the Tribunal’s reasoning when considering how the rules might apply in the more common scenario that a company remains party to a given loan relationship liability after migrating to the UK. The Tribunal’s interpretation of the rules strongly suggests that a disallowance may have been needed in this case regardless of the early redemption – a point other companies migrating to the UK will wish to take note of.
