CFM35320 - Loan relationships: connected companies and impairment: basic rules
Connection and impairment: four main consequences
CTA09/S353 explains that there are four main effects on the debits and credits that arise under loan relationships rules for impairment where the companies are connected. ‘Impairment’ here means both ‘impairment losses’ where debt is written down by a creditor, and ‘release debits’ where the creditor releases, in full or in part, a debtor from a liability.
Creditors: No debits for impairment losses
CTA09/S354 to S357 prevent a creditor company from receiving debits for impairment losses in most cases where the debtor is a connected company. There are two exceptions for
- debt-equity swaps
- insolvent creditors
Where a company makes a loan to an unconnected party it will receive relief for impairment losses computed in accordance with accounting standards. This includes cases both where the impairment losses are calculated under the incurred loss basis (IAS39, FRS26 or section 11 of FRS102) and under the expected loss basis (IFRS 9).
If the companies subsequently become connected there will be no write-back of impairment relief already given, but as a result of connection the debt will not attract further relief. The starting point will be the value of the debt in the accounts at the end of the accounting period preceding connection.
Creditors: No credits on reversal of disallowed impairment loss
A creditor company that is denied an impairment loss under S354, does not have to bring in a credit for any reversal of the loss (CTA09/S360). This applies whether or not the companies are still connected when the reversal takes place.
Debtors: No credits from releases
A debtor company is not required to bring in credits where it is released from a liability by a connected creditor (CTA09/S358), unless it is a ‘deemed release’ - explained below.
This rule is extended to debtors that were connected to a creditor but have ceased to be because the creditor has become insolvent and the connection between the two has been broken as a consequence.
A creditor company that is denied an impairment loss under CTA09/S354, does not have to bring in a credit for any reversal of the loss (CTA09/S360). This applies whether or not the companies are still connected when the reversal takes place.
Although section 360 refers to impairment losses, it will also apply where, in a period starting on or after 1 January 2005, a company reverses a bad or doubtful debt provision that was made in an earlier period. If ‘bad debt relief’ was denied in the earlier period because the creditor company was connected with the debtor, no credit is brought into account in respect of the reversal.
Debtors: taxable credits for ‘deemed releases’ in certain cases
A debtor company will not normally reflect a credit in its accounts where the creditor recognises an impairment loss, and there will be no effect on its tax computations even where the parties are connected. In the more unusual situation of the creditor formally releasing the debt, CTA09/S358 stops a connected debtor from bringing in a credit for the release. Release of connected party debt is normally ‘flat’ - there is no relief for the creditor, but no tax charge on the debtor.
But there are two exceptions to this rule where (i) a connected creditor takes over impaired debt, and (ii) where companies that already have an impaired loan relationship, become connected. In such cases a credit is brought in by the debtor in respect of a ‘deemed release’ (CTA09/S361 to S363). There are, however, certain exemptions that can apply.
F(No. 2)A 2015 amended these rules in cases where the debtor company is in significant financial distress, see CFM35420 onwards.
Connected company loans that form part of a fair value hedge
Connected company debt is required to be held on an amortised cost basis of accounting. For loans entered into in an accounting period beginning on or after 1 January 2016 the definition of amortised cost is relaxed so as to allow adjustments where the loan is part of a designated fair value hedge.
In consequence of this, for accounting periods beginning on or after 1 January 2016, an adjustment may be required where a connected company loan is released and the loan treated as being adjusted under a designated fair value hedge.
In these circumstances, the above rules dealing with debt releases do not prevent the company bringing into account a credit or debit in respect of any reversal of that adjustment.