Hexagon Properties [2022] UKFTT 00137 (TC) is another of those cases where the question to be answered is simple, and at first blush one would have thought the answer obvious. It’s only when one looks at the world through the distorting lens that is the UK’s tax legislation that the picture becomes at all fuzzy.
Let us explain.
A property developer alleged that it had suffered damage at the hands of a bank. The parties settled out of court to the tune of about £3.5m.
If the bank had paid over the £3.5m it would without any shadow of doubt have been necessary to determine the taxation consequences of the receipt by reference to the character of the damages. There’s an extra-statutory concession (D33) which is relevant in some circumstances, which may have the result that some or all of the amount received is tax-free.
But the bank did not pay over the £3.5m as such. Instead, it accepted £1.5m in full and final settlement of a pre-existing debt of £5m that the developer owed to the bank.
So what? Surely damages are damages: the fact that the mechanics of the settlement involve setting off against a debt rather than a separate receipt cannot possibly affect the tax treatment?
You’d think so: so did the company.
HMRC argued differently. Under the loan relationship rules, a company is required to bring into charge any ‘profits that arise to it from its loan relationships and related transactions’. The loan was plainly a loan relationship: its extinguishment by ‘exchange, redemption or release’ was plainly a ‘related transaction’ and the £3.5m was plainly a profit that arose from the related transaction. Ergo, the £3.5m was taxable in full under the loan relationship rules; no further enquiry was necessary.
Happily, and surely correctly, the First-tier Tribunal disagreed with HMRC. Yes, there was a loan relationship and a related transaction, but ‘Any objective consideration of what the £3.5 million arose from in this case would conclude that it arose “from” the Appellant’s claim in damages against its bank and not “from” any related transaction of its loan relationships.’ Quite so: good call.
There’s one side-line to the case though. In the course of argument, Counsel for HMRC contemplated the release by a shareholder of a debt owed to the shareholder by the company, submitting that ‘any resulting credit in the company’s accounts would be chargeable under the loan relationship regime as a profit arising from the release, and would not fall outside that regime on the basis that it really “arose from” the bounty of the shareholder in releasing the debt.’
The Tribunal agreed with that observation, while distinguishing it from the facts before it in the present case. But consider: if a shareholder (or anyone else) gratuitously donates money to a company, that receipt might or might not be chargeable to tax in the hands of the company, depending to a large degree on the motivation of the donor. It may well be taxable: but the question has to be considered in every case. But if the donor happens to be a creditor and effects the same donation by the mechanics of a release of all or part of the debt there is at the very least a considerable risk that the treatment in the hands of the company will be governed solely by the loan relationship rules. Sometimes (especially where the transaction is effected between connected companies) that may be helpful: sometimes it will not.
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