Part One explained why the ‘connectedness’ rules did not prevent Primeur Ltd (‘Primeur’) from claiming tax relief on its loan write-offs when an associated company Valley Dale Properties Ltd (‘VDP’) failed to pay its debts. This note looks at the reasons why it was nonetheless denied relief under the ‘unallowable purpose’ rules.
Primeur had loaned VDP some £476,000 secured by a legal charge over VDP’s property, and was owed a further unsecured ‘trading balance’ of £133,000.
VDP also owed money to its shareholders. Two of them (‘the Common Shareholders’) were also shareholders of Primeur: two (‘the VDP-only Shareholders’) weren’t. All the shareholder loans were unsecured.
Following sale of its main asset (a property) for less than it had hoped, VDP wasn’t in a position to repay the loans in full. Primeur got £366,000 in respect of the secured loan, writing off the balance of the loan and the whole of the ‘trading balance’; the VDP-only Shareholders wrote off £50,000; the Common Shareholders were repaid in full.
HMRC thought they smelled a rat. £476,000 of Primeur’s debt was secured. HMRC considered that any purpose Primeur might have had in deciding not to enforce the security was not among the ‘business or other commercial purposes of the company’. It was thus an ‘unallowable purpose’, which precluded Primeur from obtaining tax relief for the partial write-off of the secured loan.
The First-tier Tribunal (‘FTT’) agreed with HMRC. How could it not?
The effect of the failure to enforce the security was that Primeur ‘deliberately deprived itself of working capital whilst benefiting the unsecured creditors who were also shareholders in the company’. The FTT recognised that ‘the reason why the majority shareholders were repaid in full is because of the work that they had done to secure a good deal for the sale of the property which resulted in a knock-on benefit for everyone’ and even that it seemed ‘proper that the majority shareholders should receive some sort of reward for that result.’ But ‘in considering unallowable purpose, we must consider the purposes of the company and not the company’s shareholders or investors.’
Interestingly, the case before the FTT didn’t extend to consideration of the consequences for the Common Shareholders of their good fortune in having the full amount of their loans to VDP repaid, in contrast to Primeur and the VDP-only Shareholders. That benefit arose, of course, only because Primeur had deliberately foregone an amount of money from VDP to which it was entitled, effectively redirecting that amount from itself to the Common Shareholders. Was that therefore a ‘distribution’ made by Primeur and taxable as such in the hands of the Common Shareholders (despite the fact that it was nothing more than a repayment of the amount which the Common Shareholders had loaned to VDP)? Perhaps we shall never know.
But there is more to be mined from the Primeur case. As we have seen, the FTT held that Primeur’s tax return was incorrect: but was carelessness involved? The answer is, in effect, ‘Yes and No’, as we shall see in the third and concluding part of our commentary on this most interesting case.
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