Shinelock Ltd – payment not deductible as a loan relationship debit

In Shinelock Ltd v HMRC [2021] UKFTT 320 (TC), the First-tier Tribunal (FTT) decided that a payment made by a company to its former shareholder was not deductible as a loan relationship debit and accordingly there was no non-trading loan relationship deficit (NTLRD) to offset the chargeable gain realised on the disposal of a property.

Background

Shinelock Ltd (Shinelock) bought a property (the Property) on 31 March 2009 and disposed of it on 4 December 2014 for a gain. On 15 December 2014, Shinelock paid an amount equal to the gain to Mr Ayaz Ahmed (the Payment), who had been the sole shareholder of Shinelock until 30 September 2014 (and had later re-acquired the shares he had disposed of), and had been a director of the company until December 2014. 

The purchase of the Property had been funded from a combination of a loan from Habib Bank and funds provided by Mr Ahmed. Shinelock did not bring any chargeable gain into account in its self-assessment for the year ended March 2015.

HMRC concluded that Shinelock had realised a chargeable gain on the disposal of the Property, which was subject to corporation tax and amended Shinelock’s self-assessment to give effect to its conclusion. Shinelock appealed to the FTT.

During HMRC’s enquiry into Shinelock’s self-assessment, Shinelock’s position had been to argue that the Property was beneficially owned by Mr Ahmed, not Shinelock, such that any chargeable gain could only have been realised by Mr Ahmed (who had not been UK resident at the relevant time). By the time of the hearing before the FTT, Shinelock’s position was that it had been the beneficial owner of the Property but the Payment was deductible and this fully offset the chargeable gain. The deductibility argument was based on Shinelock having a  NTLRD equal to the amount of the Payment. It relied on alternative arguments in respect of loan relationships between Shinelock and Habib Bank and between Shinelock and Mr Ahmed.

FTT decision

The appeal was dismissed.

In the view of the FTT, the Payment could not be a distribution within the meaning of section 1000(1), Corporation Tax Act 2010 (as HMRC argued), as Shinelock was contractually liable to make the Payment to Mr Ahmed and the FTT did not accept that a payment to discharge a contractual obligation can be said to be made “out of the assets” of a company for the purposes of section 1000(1). 

Nevertheless, the FTT concluded that the Payment was not deductible as a loan relationship debit and accordingly there was no NTLRD to offset the chargeable gain.

Section 307(2), Corporation Tax Act 2009 (CTA 2009), sets out the general rule that the amounts to be brought into account as credits and debits for any period are those that are “recognised in determining the company’s profit or loss for the period in accordance with [GAAP]”. In the present case, the Payment was not recognised in Shinelock’s accounts in determining its profit or loss for the relevant period.

Section 307(3), provides that the credits and debits to be brought into account in respect of a company’s loan relationships are the amounts that “when taken together, fairly represent” for the accounting period in question “(a) all profits and losses of the company that arise to it from its loan relationships and related transactions (excluding interest or expenses), (b) all interest under those relationships, and (c) all expenses incurred by the company under or for the purposes of those relationships and transactions". Section 307(4) provides that "Expenses are only treated as incurred as mentioned in subsection (3)(c) if they are incurred directly (a) in bringing any of the loan relationships into existence, (b) in entering into or giving effect to any of the related transactions, (c) in making payments under any of those relationships or as a result of any of those transactions, or (d) in taking steps to ensure the receipt of payments under any of those relationships or in accordance with any of those transactions”.

In the FTT's view, the Payment represented a calculation of the gain realised by Shinelock on the sale of the Property. The Payment was not a debit in respect of the loan made by Mr Ahmed which fairly represented any losses to Shinelock arising to it from that loan. Mr Ahmed’s own evidence was that he provided a variety of assistance to Shinelock, which the FTT regarded as consistent with him being a shareholder in the company. Similarly, the FTT did not accept that the agreement to pay any gain could be said to be an expense incurred by Shinelock directly in bringing the loan relationship into existence. It was a consequence of the wider arrangement between the parties.

Comment

If Shinelock's accounts had been drawn up on the gross basis, rather than the net basis, the Payment would have been recognised in Shinelock’s accounts in determining its profit or loss for the relevant period. This decision underlines the importance of considering the interaction between accounting principles and tax legislation.

The decision is also a timely reminder of the importance of formally documenting any arrangements entered into and of seeking appropriate professional advice when drafting such documentation.

The decision can be viewed here.