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Back to basics Tax on bad debts W - Gabelle Tax Consultants

back to basics Tax on bad debts SPEED READ The inability to recover and pay W. ith careful planning the impact of bad debts on a business can be reduced. In outstanding debts can often have a serious effect on relation to VAT it is surprising how many continued performance of a business. The valuable boost businesses do not make a VAT bad debt relief claim. to cashflow that tax reliefs for bad debts can provide is The aim of this article is to remind practitioners of often vital. Conversely, the release of debts can give rise the main tax aspects which should be considered to unwelcome credits chargeable to corporation tax.

16 March 2012 ~ www.taxjournal.com nthe amount of VAT and the accounting period it was paid to HMRC; nany payment received for the supply; and ndetails of entries in the ‘refunds for bad debts

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Transcription of Back to basics Tax on bad debts W - Gabelle Tax Consultants

1 back to basics Tax on bad debts SPEED READ The inability to recover and pay W. ith careful planning the impact of bad debts on a business can be reduced. In outstanding debts can often have a serious effect on relation to VAT it is surprising how many continued performance of a business. The valuable boost businesses do not make a VAT bad debt relief claim. to cashflow that tax reliefs for bad debts can provide is The aim of this article is to remind practitioners of often vital. Conversely, the release of debts can give rise the main tax aspects which should be considered to unwelcome credits chargeable to corporation tax.

2 A. when advising corporates. company can claim impairment losses in respect of bad Brief overview of corporate debt debts under the loan relationship rules where generally Where a company stands in the position of a creditor tax follows accounting treatment. Matters become more or debtor as regards any money debt and the debt complex however where a connection between creditor arises from a transaction for the lending of money, a common example being a bank or inter-company and debtor companies exists. The set-off of impairment loan, a loan relationship will exist.

3 Losses also depends on whether the debt arose from a The main provisions on loan relationships (LR) are trading or non-trading relationship. Businesses can also contained in CTA 2009 Parts 5 and 6 and the sections recover VAT on bad debts subject to relevant conditions. referred to in this article relate to those provisions unless otherwise stated. Trade debts arising from Martin Mann is a Director at Gabelle LLP, providing the provision of goods and services and not from the independent tax support for accountants and other lending of money are not LR. However, trade bad professionals.

4 Martin advises on direct tax issues debts ' are brought within the LR rules by virtue of s affecting owner managed businesses. Email: martin. 481. tel 020 7182 4745. Under the LR rules the tax treatment of profits and losses arising on a company's LR are based on the company's accounts in accordance with generally accepted accounting practice. The amounts reflected Vaughn Chown is a Partner and Head of VAT. at Gabelle LLP. Vaughn advises accountants and in the accounts are treated as income or expenses businesses on all VAT matters and has represented or in the case of bad debt provisions or debt releases many cases in the VAT Tribunal including takeaway recognised by creditors' impairment losses the relief food, mixed and multiple supplies, VAT liabilities for which will depend on whether the LR is derived and VAT bad debt relief.

5 Email: from trading or non-trading activities. However, this ; tel: 020 7182 4748. accounts based position is usually set aside where there is a connection between the creditor and debtor as explained below. there is no tax charge on the debtor company. In effect the transaction is tax neutral. The same situation now Providing for/releasing bad debts applies to the release of trade debts following the 2009. In most situations involving unconnected parties changes which corrected an asymmetrical position a creditor company would choose to provide for which existed in relation to the release of trade debts bad debts in its books while continuing to chase prior to 22 April 2009.

6 For payment. The provision would give rise to an impairment loss but as the amount still remains Trading v non-trading outstanding, there would be no effect on the debtor The direct tax treatment of bad debts will depend company. At the same time the creditor company on whether the debt arose from a trading or non- should consider its VAT position assuming the debt trading relationship. When considering the creditor related to a taxable supply of goods or services. The relationship, a company has a trading LR where the relevant conditions are outlined at the end of this relationship is for the purpose of a trade it carries article.

7 On (s 297). This will usually only include banks and There may be situations however where there is other financial traders. Relief for impairment losses no chance of recovery and the debt is released. In this in such situations would follow normal rules for case, while the creditor company position remains setting off corporate losses. the same, the debtor company would be required to Where the creditor company has a loss derived recognise a taxable profit in respect of the release. This from a non-trade LR such as that shown in Example is highlighted in Example 1 where a trading company 1, any loss will be relieved in accordance with ss X' had sold goods to an unconnected company Y.

8 457 459. Usually, a claim is made to offset this against Company Y had entered into insolvent liquidation and total profits of the company for the deficit period. company X subsequently released the debt . Company On the debtor side, on the basis the LR is for the Y can benefit however where it accounts for the release purposes of its trade, any credit arising from the using an amortised cost basis of accounting as this release of the debt would generally be included in its requirement is removed by virtue of s 322. trading profit subject to the exception in s 322. Subject to exceptions highlighted below, there is no impairment loss for the release of bad debts where the Connected companies companies are connected for the accounting period in Companies are connected under LR rules if one which the loss arose (s 354).

9 Conversely under s 358, controls the other or they are both under common 16 March 2012 ~ 17. control, so companies in the same group are Swapping debt for equity (s 356). connected (s 466). Control for these purposes is Where the creditor accepts shares in the debtor narrowly defined in s 472 as the power of a person company as full and final settlement of the debt , to secure that the affairs of the company are releasing any amounts in excess of the value of conducted in accordance with the person's wishes: shares, an impairment loss can be claimed if: n by means of the holding of shares or the n the creditor treats the liability as discharged possession of voting power in or in relation to (hence no credit in debtor company as the debt the company or any other company, or is treated as paid).

10 N as a result of any powers conferred by the n it does so in exchange for ordinary shares; and articles of association or other document n leaving aside the share/equity swap, there is regulating the company or any other company, no connection for LR purposes between the eg, the power to appoint the majority of the creditor and debtor companies in the accounting Board. period consideration is paid. The legislation refers to person' in the singular but If as a result of the transaction the companies consistent with the findings in Floor v Davis [1979] become connected the normal rules will apply to STC 379, HMRC accepts this can include persons' other LR which may exist in the same accounting (see HMRC's Corporate Finance Manual at CFM period.)


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