Loan relationships and imported losses

The Upper Tribunal has in part allowed the taxpayer's appeal in UK Care No. 1 Ltd v HMRC [2026] UKUT 90 concerning the extent to which losses on loan notes were referable to the period when the taxpayer was not UK resident and, as such, disallowed. The UT agreed with the FTT that the "compensatory" part of the loss attributable to the increase in market value of the loans was referable to the period before the company became UK tax resident. However, unamortised costs and discount which had been spread across the life of the loans and became payable on early redemption was not referable to the pre-migration period simply because those amounts were paid / arose on issue. Spreading those costs / discount over the life of the loan was in line with commercial reality such that the loss referable to those amounts was not a pre-migration loss.

Background

UKC1 was a Guernsey SPV company which acted as the issuer of certain loan notes secured by the UK care home business of the BUPA Group. In 2016, BUPA wanted to sell a number of the care homes which formed part of the security package for the loan notes. In order to facilitate this sale, UKC1 was acquired by the BUPA Group, became UK resident and then redeemed the loan notes. The redemption gave rise to an accounting loss of just over £150m, being the difference between the amount UKC1 had to pay to redeem the loan notes and the carrying value of its liability under the loan notes in its accounts. UKC1 brought into account a loan relationship debit in respect of this loss in its corporation tax return for the period ending 31 December 2016.

HMRC initially rejected the claim to treat the £150m loss as a loan relationship debit in its entirety on the basis that it was excluded as an imported loss by CTA 2009 s.327. Essentially, s.327 restricts the amount of a loss that can be brought into account. A loss arising in connection with a loan relationship cannot be brought into account if it is wholly or partly referable to a time when the company claiming the loss would not have been subject to UK taxation had there been a profit.

The outstanding principal under the loan notes was £235m and the market value of the notes when UKC1 became UK tax resident was £325m. The amount payable on redemption was £381m. This was made up largely of two elements: a compensatory element of £90m (the difference between the outstanding principal and the market value of the notes) and a penalty element of £56m (essentially a penalty for early redemption). The balance of the loss of £4m was made up of unamortised discount and issue costs (UKC1 used an amortised cost basis of accounting for the loans rather than fair value).

Before the FTT, HMRC accepted that the £56m penalty element was not an imported loss. However, the FTT agreed with HMRC that the remainder of the loss was restricted as an imported loss. UKC1 appealed.

Decision of the UT

UKC1's first argument that none of the amounts claimed were "losses". In fact, they were all "expenses" and expenses must be distinguished from losses and are dealt with under CTA 2009 s.306A and not s.327. In particular, UKC1 pointed out that s.306A clearly distinguished between "losses" (in paragraph (1)(a)) and "expenses" (in paragraph (1)(c)) whilst s.327 only referred to imported "losses".

The UT rejected this argument. Whilst it accepted that the relevant amounts in this case would all fall to be treated as "expenses", the UT agreed with HMRC that a "loss" is generally a compound concept resulting from a computation involving the deduction of expenses. As such, if Parliament had intended to exclude expenses from s.327 it would have been necessary to expressly exclude losses. In any event, the wording of s.306(1)(a) contained express language excluding expenses from losses, indicating that in the absence of such language, losses include expenses. Section 306 merely distinguishes losses and expenses because only certain categories of expense are to be brought into account in terms of loan relationships. Moreover, the UT accepted that the purpose of s.327 in restricting relief for imported losses would apply equally to losses comprising expenses that were referable to a period when the company was not UK resident.

Secondly, UKC1 argued that the loss claim was made up of expenses which were all referable to the remaining contractual term of the loan notes and not the pre-migration period. It was common ground that that a loss will be referable to a pre-migration period only if, at the time of migration, the loss already existed or had already arisen as a matter of commercial reality. This does not require the loss to have been triggered or crystallised prior to migration. An unrealised or unrecognised loss is sufficient, provided it already existed as a matter of commercial reality.

On this point, the UT rejected UKC1's argument that the compensatory amount referable to the market value of the notes was simply referable to the post-migration period on the basis that it simply arose due to the early redemption of the notes. At the time that UKC1 became UK resident, the market value of the notes (on which the compensatory payment was based) was £325m. However, UKC1 argued that the decision to redeem did not merely crystallise an existing loss, it created a loss that did not previously exist. The UT held that the FTT had approached the question of whether this element of the loss was "referable" to the pre-migration period correctly and considered that the FTT had reached the correct conclusion. As a matter of commercial reality, the compensatory element of the loss were referable to the pre-migration period when the market value of the loans had increased. This element of the loss was essentially attributable to pre-migration changes in market conditions.

However, the UT overturned the FTT decision in relation to the £4m of unamortised discount and issue costs. The issue costs were an integral part of obtaining the funding and could properly be recognised over the expected term of the loans. The time the issue costs were incurred was not determinative and the issue costs were written off over the life of the loans. Whilst they were paid at the time of issue, the unamortised issue costs were written off at the time of redemption and that reflected commercial reality. Equally, the unamortised discount was effectively recognised as an expense over the lifetime of the loan notes. UKC1 was recognising that obligation by amortising the loan notes over their term and that reflected the commercial reality that the discount was a cost of obtaining the loan. The fact that market conditions changed and the fair value of the loan notes increased over time had no effect on the obligation of UKC1 to pay the discount at the end of the term or on early redemption.

Comment

The decision considers important concepts in the context of the loan relationship rules and, in particular, the scope of the restriction for imported losses in section 327. Ultimately, despite the technical arguments, the UT has largely applied a test of commercial reality in determining the extent of the relatively wide language used by section 327 concerning whether a loss is "wholly or partly referable to a time when the relationship was not subject to United Kingdom taxation".