Background
The United Kingdom (“UK”) has specific corporate tax rules on the taxation of loan relationships (parts 5 and 6 of the Corporation Tax Act 2009 (the “Loan Relationships Regime”)). The Loan Relationships Regime contains rules at section 327 of the Corporation Tax Act 2009 which disallow relief for any “losses” that are wholly or partly referable to a time when the loan relationship was not subject to UK taxation (the “Imported Loss Rules”).
The recent First-tier Tribunal (“FTT”) case of UK Care No 1 Ltd v HMRC [2024] UKFTT 542 (TC) is the first case to consider the Imported Loss Rules, and considers how those rules, and in particular the test of “referability”, should be applied.
The Case
The case concerned a Guernsey resident company (the “Issuer”) that issued loan notes at an initial discount prior to migrating to the UK in 2016. The loan notes were accounted for by the Issuer on an amortised cost basis. That is, the liability of the loan notes was shown in the accounts of the Issuer at a figure based on their historic cost (i.e., issue price less transaction costs) but with the initial discount and transaction costs being amortised over the life of the loan.
The Issuer redeemed the loan notes early, at a premium, resulting in approximately £150 million of “losses”, which the Issuer sought to claim as “loan relationship debits” in its tax return. However, HMRC sought to disallow approximately £94 million of the “loss”, which was the difference between the carrying value of the loan notes in the Issuer’s accounts on the date the Issuer became UK tax resident and the fair value of the loan notes on that same date. HMRC argued that the £94 million of “losses” were “referable” to the pre-migration period and therefore were disallowed under the Imported Loss Rules.
The key question considered by the FTT was how to determine whether a “loss” was referable to a pre-migration period.
The FTT held that the question of referability was an objective test. Broadly, would an informed an independent third party consider the “loss” to have arisen or existed in the Issuer’s pre-migration period? In particular, the legislation required that the “loss” must exist or have arisen as a matter of commercial reality prior to the migration of the company to the UK as the loss could not otherwise be imported. It was therefore appropriate to ask “whether the loss 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.”[1]
The FTT considered it was highly relevant that the Imported Loss Rules do not apply where fair value accounting is used in respect of the loan relationship in question. The FTT stated that that feature of the Imported Loss Rules strongly supported the proposition that changes to the factors used to calculate fair value had a significant part to play in determining whether a “loss” was referable to the pre-migration period as a matter of commercial reality.
In the case before the FTT, the tribunal judge concluded that it was clear that “losses” of approximately £94 million were referable to the pre-migration period as they existed or had arisen as a result of changes in the market during the pre-migration period. While the “loss” had not crystallised, it already existed in the pre-migration period as a matter of commercial reality.
The facts of this particular case are unusual, and take place in the context of a complicated group acquisition. However, the case sheds important light on the interpretation of the Imported Loss Rules and will continue to be relevant for companies that are planning to enter the UK tax net.
[1] Paragraph 82 of the judgment, UK Care No 1 Ltd v HMRC [2024] UKFTT 542 (TC).
