Fundamentals of the Loan Relationship Rules in Practice

Part One

Definition of a Loan Relationship and Money Debt

• Loan Relationship Rules Course Core Principles
• A loan relationship involves financial arrangements defined by monetary debts between entities, typically under IFRS 9 (Financial Instruments) for recognition and measurement.
• A money debt arises from monetary obligations, often subject to interest income or expenses under IAS 23 (Borrowing Costs).
• Examples:
• Money Debt: Loans (IFRS 9), bonds, overdrafts, trade debts with contractual interest clauses.
• Not Money Debt: Equity investments (IAS 32), grants, barter transactions.
• Transactions Excluded from Loan Relationships:
• Settlements involving services or goods (e.g., IAS 2 for inventory or IAS 38 for intangible assets).
• Deemed Loan Relationships:
• Financial instruments treated as loans for tax purposes under UK Corporation Tax Act (CTA) 2009, Part 5.
• Examples include finance leases (IFRS 16) and embedded derivatives (IFRS 9).

Debt Securities Issued to Represent a Debt Owed to a Supplier

• Tax Treatment Impact:
• Debt reclassification affects the recognition of interest and principal under CTA 2009, with IAS 39/IFRS 9 guiding the derecognition and modification of financial liabilities.
• Examples:
• Supplier’s invoice converted into tradable bonds affecting interest timing differences for tax.

Types of Loan Relationships: Trading vs. Non-Trading

• Classification and Importance:
• Trading Loan Relationships: Linked to operational trade; taxed under CTA s296.
• Example: Working capital loans for inventory purchases (IAS 2).
• Non-Trading Loan Relationships: Linked to investments or financing activities; taxed under CTA s300.
• Example: Loans for acquiring long-term investment properties (IAS 40).
• Loan Relationship Rules Training considers Changes in Intention:
• A shift from trading to non-trading (or vice versa) requires tax adjustments per IFRS 9 reclassification rules.

Computational Aspects

• Recognition and Measurement:
• Use of amortised cost or fair value per IFRS 9.
• Amounts in:
• Profit and Loss (IAS 1).
• Other Comprehensive Income (OCI) for unrealised gains/losses (IFRS 7).
• Shareholders’ Funds.
• Examples:
• Accrued interest recognised in P&L (IFRS 9).
• Foreign exchange differences recorded in OCI (IAS 21).

Dealing with Non-GAAP Accounting Treatments of Loans

• Key Considerations:
• HMRC materiality often diverges from IFRS materiality (IAS 1).
• Deferred tax (IAS 12) implications for non-GAAP adjustments.
• Examples:
• Loan issue costs expensed under foreign GAAP may need adjustments for UK tax.

Accounts Prepared Using Foreign GAAP

• Required Adjustments:
• Aligning foreign GAAP entries with UK tax laws (e.g., IFRS-compliant financial statements).
• Examples:
• A UK branch using U.S. GAAP (ASC 842 for leases) needing reclassification to IFRS 16.

Loan Relationship Rules in Practice Course Part Two

Capitalised Interest and Tax Implications

• Tax Treatment of Capitalised Interest:
• GAAP Taxable Assets: Assets eligible for capitalisation under IAS 23.
• Non-GAAP Taxable Assets: Expenses requiring reclassification per UK tax law.
• Examples:
• Building construction capitalisation (IAS 16).
• Internal-use software development (IAS 38).
• Development properties for sale (IAS 2).

Perpetual Debt Issues

• Accounting Treatment:
• IFRS 9 guides classification as liability or equity (IAS 32 for hybrid instruments).
• Tax Implications:
• Adjustments if perpetual debt resembles equity.

Connected Company Loan Relationship Issues

• Definitions:
• Connected Company: Defined under CTA 2009.
• Amortised Cost: Changes pre-/post-2016 per IFRS 9.
• Tax Implications:
• Write-offs or releases under IFRS 9 impairment rules.
• Examples:
• Loans pre-2016 following IAS 39.
• Loans post-2016 aligned with IFRS 9.

Late Paid Interest Rules

• Principles:
• Interest deductions deferred under CTA s374.
• Examples:
• Payments delayed beyond one year disallowed for tax relief.

Transfer Pricing and Connected Company Loans

• Impact of Transfer Pricing Rules:
• Adjustments under OECD guidelines or HMRC’s TP Manual.
• Thin capitalisation rules under IAS 24.
• Examples:
• Loans exceeding arm’s length terms disallowed for deductions.

Unallowable Purposes Rule

• Definition:
• Loans without legitimate business purposes.
• Adjustments:
• Interest disallowed under CTA s441.
• Examples:
• Financing non-business assets like shareholder distributions.

• Loss Relief:
• Offsetting against profits under CTA s457.
• Examples:
• Losses pre-2017 and post-2017 under evolving tax regimes.

Close Company Issues

• Write-off treatment adjusted for participator being officers/employees.
•  Non-Market Loan Anti-Avoidance Rules
• Examples:
• Tax implications under CTA s455.
• Loans to Participators:
• Overview:
• Loans to non-resident entities under non-market terms adjusted for UK taxation.
• Examples:
• Anti-avoidance rules applied to below-market rate loans.
• Notional Interest Expense and Income
• Principles:
• Identification of P&L items not under IFRS 9 loan rules.
• Examples:
  • Pension liabilities (IAS 19).
  • Discounted provisions (IAS 37).

 
Tax Issues Around Convertible Debt

• Accounting Framework Differences:
• FRS 102 vs. IFRS 9 for convertible instruments.
• Examples:
• Fixed share convertible bonds taxed differently under IAS 32 versus FRS 102.
• Variable share conversions under IFRS 9.