CFM31110 - Loan relationships: what are loan relationships: guarantees and loan relationships - example

A Ltd borrowed £100,000 from Bank plc (Bank).

As part of the conditions for getting the loan, A Ltd obtained a guarantee from G Ltd.

The money debts

As a result, there is a loan relationship between A Ltd and Bank plc. A Ltd has a debtor loan relationship and Bank plc, a creditor loan relationship. At this stage G Ltd is not party to a loan relationship.

After having paid all interest charged on the loan, A Ltd defaults on its obligation to repay the principal and G Ltd now owes Bank plc £100,000 under the terms of the guarantee.

Until G Ltd settles the £100,000, there is a money debt due from G Ltd to Bank plc arising from the guarantee. There has been no ‘lending of money’ so G Ltd’s liability to Bank plc will not create a loan relationship. However, until settlement G Ltd’s debt to the bank will be a relevant non-lending relationship of G Ltd within PT6/CH2.

Once G Ltd has paid its money debt to the Bank plc, G Ltd will have a money debt due from A Ltd arising from G Ltd’s ‘subrogation’ rights (see {CFM31100}). Depending on the circumstances, this will either a creditor loan relationship or a relevant non-lending relationship of the borrower, A Ltd.

Amounts to be brought into account

Once A Ltd defaults, G Ltd has a debtor relevant non-lending relationship representing its indebtedness to Bank plc, assumed accounting carrying value £100,000.

The settlement of its liability by G Ltd, under the guarantee, is the extinguishment of a liability - see CFM31140. However, under GAAP, no amount should be recognised in determining A Ltd’s profit or loss. The bookkeeping entries are simply, Dr liability to Bank plc £100,000, Cr liability to G Ltd, £100,000. Thus there is no amount to bring into account for tax.

After it makes the payment to bank, it will be owed £100,000 by A Ltd as result of subrogation, see CFM31100. The payment to Bank plc did not of itself result in a loan relationships debit. But now G Ltd has a creditor loan relationship or relevant non-lending relationship in respect of the amount owed by A Ltd. If A Ltd cannot repay, or is unlikely to be able to repay, any amount that G Ltd writes off or releases may give rise a debit treated under GAAP as an item of profit or loss,

  • for impairment (CFM33220), or
  • as a loss on a related transaction (CFM31120).

However, if G Ltd and A Ltd are connected, the debit would not be taken into account as a tax deduction. This is the case whether the subrogation gave rise to a creditor loan relationship, or a relevant non-lending relationship:

  • Where there is a loan relationship, S354 applies to deny relief for the impairment loss.
  • Where there is a relevant non-lending relationship, S482(2)(d) and S481 apply the loan relationships provisions in the same way as for a matter falling within PT5 - so again S354 would deny relief for the impairment loss.

See CFM35300 for further details of connected companies and impairment