Advances to company with no immediate prospect of repayment still loan relationships

The First-Tier Tribunal (FTT) has rejected HM Revenue and Customs' (HMRC) argument that a loan made to a company with no immediate prospect of repaying it, or interest on it, was not a “transaction for the lending of money”: CJ Wildbird Foods Ltd v HMRC [2018] UKFTT 341. HMRC were not entitled to recharacterise the payments as contributions of capital in such circumstances.

The FTT pointed out that there were many modern business scenarios where monies are lent without any immediate prospect of repayment or payment of interest. In this case, the terms of the loans were clearly documented and there was no reason to consider that the payments were anything other than advances by way of transactions for the lending of money. The fact that HMRC might consider the possibility of repayments unrealistic, did not affect the true character of those loans.

Background

The appellant, a company with a profitable business in the wildlife sector, bought a 50% interest in a company running a bird forum website, BFL. Arrangements between the appellant and BFL were conducted on an arm’s length basis. The appellant entered into a shareholders’ agreement including terms governing investors’ loans to be made to BDL, including interest and repayment terms. The appellant made a series of loans to BFL over a number of years. None were repaid and no interest was paid on those loans, as BDL had very little income. During 2013 to 2015, the appellant made further loans amounting to some £450,000 to BFL. The appellant claimed a non-trading loan relationship debit equal to the amounts of these loans on the basis that the loans were unlikely to be recoverable in the short term and had therefore been fully provided for in the appellant’s accounts. HMRC sought to amend these tax returns to add back the loan relationship debits.

Decision of the FTT

HMRC essentially argued that the amounts paid by the appellant to BFL in 2013 to 2015 were not loans for the purposes of the loan relationship rules. HMRC contended that the payments lacked the hallmarks of a loan. It was clear that interest had never been charged or paid on the advances and that BFL lacked the capacity to repay the loans or any credible plan as to how it might do so. The advances were more akin to capital contributions. HMRC relied on a decision of the Court of Appeal from 1937, Smart v Lincolnshire Sugar Ltd in which the court had contrasted a “loan” with “a payment of money subject to a contingent liability in certain events to repay”.

The FTT rejected that analysis. It was clear from the shareholders’ agreement that the advances by the appellant were, in law, repayable with interest and had not been formally written off. The advances were clearly from a transaction for the lending of money. The FTT considered the case of Smart and whether the advances should be recharacterised, but considered that the Smart case was clearly distinguishable from the present case. Smart involved the contrast between a loan and a complex scheme of statutory subsidies, which contemplated from the outset that some or all of the payments might never fall due for repayment.

HMRC’s argument was essentially that, given that at the time each loan was made, BFL could not repay it or interest on it and had no plausible plan for doing so, it could not be properly said that the resultant debt arises from a transaction for the lending of money. But the FTT pointed out that the “modern business world has many famous examples of companies, especially in the technology sector, with no cash and no immediate prospect of generating a profit which go on to be very successful. Clearly the appellant considers BFL potentially to be such a company and is therefore prepared to subsidise its running costs by way of loan for the time being in the hope of obtaining repayment of some or all of its loans in due course, possibly with a gain on its share investment as well.”

A correct analysis of the situation was that the “loans have been advanced as a matter of arm’s length negotiation between the two parties, there is an obligation to repay (as recognised by both companies in their respective audited accounts and confirmed in evidence), and the fact that the appellant may well not recover some or all of its money is neither here nor there. It has made a commercial judgment that it is in its best interests to continue to support BFL by continuing loans, and the fact that HMRC may disagree with that judgment is irrelevant to the underlying nature of the transaction”.

The FTT accordingly allowed the appellant’s appeal.

Comment

The decision highlights the fact that, in the absence of sham, the contractual arrangements reached at arm’s length between the parties will determine the correct characterisation of the payments. In this case, they were clearly intended to be advanced as loans, under the terms of the shareholders’ agreement, even though there were no immediate prospects of repayment or payment of interest. These factors did not justify HMRC’s attempt to recharacterise the payments as contributions of capital.