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HM Revenue and Customs Brief 01/10

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Issued 14 January 2010

Dairy Farmers of Britain: Tax treatment on shares and debt

Introduction

The purpose of this note is to discuss the tax treatment that will be available to the members of Dairy Farmers of Britain (DFB) in respect of their shares and debt in the company. This summary of the tax position is necessarily brief and omits some details. There is more detail in the ‘Questions and Answers’ below but if, after reading those, you are not certain how the rules apply to you, you may need to seek professional advice.

Who is covered by this note

These notes focus on the tax treatment of members who are individuals. The treatment of members who are companies is different in some important respects, in particular because there are special rules for the treatment of debt in computing profits for Corporation Tax purposes. For advice on losses arising to companies which are members of DFB, please contact the company's agent or the tax office which deals with its Corporation Tax affairs.

Income Tax treatment

Your sales to DFB were done on terms that allowed DFB to retain a proportion of the sale price (latterly in a Member's Investment Account). Normally, you would have recognised the amounts retained by DFB as taxable receipts within turnover in the annual accounts. However, for accounts prepared after the receiver was appointed (3 June 2009) you need not include these retained amounts in turnover, because accountancy practice recognises the very poor prospect of any actual recovery of this money.

In addition you can deduct trade debts, such as unpaid milk cheques, to the extent that those debts were not and will not be received in computing your profits for the year in which those debts become bad.

None of the other losses described attract relief for Income Tax purposes.

Treatment of shares in DFB

The £5 Ordinary shares that were issued to you when you joined DFB, the 'B' shares, and any Preference shares that you hold are now of negligible value. If you want you may therefore make a 'negligible value claim' and claim a capital loss on the shares even though you still own them.

Find out more about making a Negligible Value Claim

Whether any capital losses will be available for the 'A' Ordinary shares that you received in March 2009 when certain debts were converted into shares is another matter. A lot depends on the type of debt that was converted into those shares.

Types of debt for Capital Gains Tax purposes

Essentially debt falls into two categories: 'simple debt' and what is referred to as 'debt on a security'.

If you did not acquire the debt from someone else, a simple debt is exempt from Capital Gains Tax and any loss is not allowable.

In contrast, a debt on a security may be liable to Capital Gains Tax provided it is not what is known as a 'qualifying corporate bond'.

The capital gains rules do not provide a specific definition of simple debt or debt on a security but decisions made by the Courts in a number of cases allow us to recognise a debt on a security. The main requirement is that, to be a debt on a security, the debt must be capable of being held as an investment. There are a number of factors to be taken into consideration when deciding whether the debt can be held as an investment for the purposes of capital gains. These will include: scope for appreciation as well as depreciation in value, any other actual or potential yield on the amount of the debt, and the terms under which the creditor may realise on the value of their debt either by redemption or disposal to a third party.

A qualifying corporate bond is a bond issued by a company such as DFB to any person who lends it money under certain conditions. The main conditions are that:

  • it is a debt on a security
  • it is a normal commercial loan
  • it is expressed in pounds sterling, and
  • there is no provision within the agreement for the bond to be converted into or redeemed in a currency other than sterling

A qualifying corporate bond is exempt from Capital Gains Tax and so, as with simple debts, any loss that is made on its disposal is not an allowable loss.

HMRC have received a number of documents relating to the issues of shares, conversion of debt into 'A' shares and the various types of debt held by members in the company. Any decision made by HMRC on how the tax rules will apply to the shares and debt has to be based on the facts and this will include the documents that have been provided to us. What follows is a statement on HMRC's view on the outcome of this process. There is a list of the documents seen by HMRC in Appendix A of this note. If any member has any other document that they consider would have a bearing on the decisions reached by HMRC then they are invited to send them to HMRC at the address shown at the end of this note.

DFB's debts

The documents we have seen suggest that all of the debts between DFB and its members were expressed in pounds sterling and none of them were capable of being redeemed in or converted into any other currency.

Loan Stock

All the Loan Stocks issued by DFB (Loan Stock 2012, 2014, 2015, 2016, 2017 and 2018) have the characteristics of being a debt on a security but they also appear to meet all the conditions for being qualifying corporate bonds. Losses on them are therefore not allowable losses.

Member's Liability Loans, the Member Capital Accounts and the Member Investment Accounts

The information shown in the documents clearly suggest that these are simple debts. Losses on their disposal are therefore not allowable losses.

Conversion of debt into 'A' Ordinary Shares

Previously we referred to the 'A' Ordinary shares that were issued in March 2009 on the conversion of certain debts. These shares are now of negligible value and you will be able to claim an allowable loss when you make a claim to that effect or any loss on an actual disposal. However the amount of the loss can only be equivalent to the allowable cost of the shares when they were acquired. The allowable cost depends on the type of debt that was converted. If the debt was a simple debt then the cost will be treated as the market value of the shares at the date they were issued. The same will apply if the debt was a debt on a security and a qualifying corporate bond. On the other hand, if the debt was neither a simple debt nor a qualifying corporate bond then the cost will be the amount of the debt.

The debts which were converted into 'A' Ordinary shares were Member's Liability Loans, the Member Capital Accounts and the Member Investment Accounts. These debts, as mentioned above, were simple debts and so the cost of the 'A' shares has to be the market value at the date they were issued 27 March 2009. From the information seen by HMRC it would appear likely that the market value at that date was £nil.

If your 'A' shares were received in exchange for Preference Shares rather than in exchange for debt then their cost will be the cost of the Preference Shares.

Summary

To summarise, the position as it stands at the moment is that where members make a claim to negligible value or when they dispose of the shares or debt they held in the company the only capital losses which appear to be available are losses on the £5 Ordinary shares, the 'B' shares and on 'A' Ordinary shares received in exchange for Preference Shares. Appendix B to this note sets out in tabular form the approach that will apply to the various shares and debts.

As mentioned at the beginning of this note, this is based on information provided to HMRC but if any member has documents which they consider might have a bearing on the views taken by HMRC then they are asked to send it to HMRC who will gladly consider whether they can change their view.

As mentioned in the note if you have any information that you think is relevant to what is said above please forward it to:

Rob Clay
CAR (CG Technical)
HMRC
Royal House
Prince Gate
2-6 Homer Road
Solihull
West Midlands
B91 3WG
 

Questions and answers

Why are my losses not allowable against my profits which are charged to income tax?

With the exception of a specific statutory override, as described above capital losses incurred cannot be relieved against profits charged as income. In general only losses incurred on trading account, such as unpaid milk cheques are allowable against profits charged to income tax. To the extent that milk cheques were not and will not be received the loss so incurred can be allowed for income tax purposes in the year that those debts become bad.

Can I get any other tax relief for losses on my investments in DFB?

Whether relief is available will depend on the exact type of investment you hold. If you hold shares then losses when you dispose of, or are treated as disposing of, them will be allowable against your capital gains on other disposals. Debts receivable by you are also assets and they too may produce losses or gains when you dispose of them or when they are redeemed or satisfied, but there are several types of debt and the treatment of losses may vary between types.

Is the position different for members who are companies as opposed to members who are individuals?

Yes. The treatment of losses on debts will often depend on whether the creditor is a company or an individual. These notes relate to individual members only.

Why do you say that my Members Investment Account is not an 'investment'?

The word 'investment' has a particular meaning for our purposes. When using it in connection with a debt which is a debt on a security, the Courts use it to mean an asset which a person might choose to own because there was a chance that it might increase in value (as well as a chance that it would fall in value instead) and any increase or fall could be realised by the owner. So their ownership carried a risk as well as a potential reward. A bank deposit account will not increase in value however much profit the bank itself makes: although it may of course pay interest, the amount invested will not increase. By contrast, a share in the bank may rise or fall in value. The deposit account represents a simple debt rather than an investment for capital gains tax purposes. The documents we have seen all suggest that the Members' Investment Accounts (as well as the Members' Liability Loans and the Members' Capital Accounts) are like bank deposit accounts in that their value could not increase other than by members paying more money into them, and the restrictions on the transfer of the debts from the original member to anyone else would have prevented any gain or loss being realised

What about my Loan Stock?

Losses on Loan Stock issued by DFB will not be allowable losses. This applies to all years' Loan Stock, that is 2012, 2014, 2015, 2016, 2017 and 2018.

Is the Loan Stock an 'investment' for Capital Gains Tax purposes?

The various Loan Stocks issued by DFB are evidence of debts between members and the company. The documents we have seen suggest that the Loan Stock was more easily transferable between members and other people, and the amount a buyer would be prepared to pay for it would depend on the rate of interest it carried and the prospects of DFB (the 'credit risk'). These factors gave Loan Stocks the character of investments for tax purposes, and so they would appear to be securities. That would be consistent with the treatment of loan stock commonly issued by companies.

Why are losses on Loan Stocks not allowable?

Although securities are generally liable to Capital Gains Tax there is a special class of security, known as qualifying corporate bonds, which are outside the scope of Capital Gains Tax. Gains on qualifying corporate bonds aren't taxable and losses aren't allowable.

To be a qualifying corporate bond, a security must have certain properties:

  • firstly, the debt represented by the security must be a normal commercial loan (we think the sums loaned by members to DFB in exchange for Loan Stock were normal commercial loans)
  • secondly, the Loan Stock must be expressed in pounds sterling
  • thirdly, the Loan Stock must not be able to be converted into any other currency
  • fourthly, the Loan Stock must be redeemable only in pounds sterling

All the documents we have seen suggest that the Loan Stocks were in pounds sterling and there is no evidence that they were redeemable in any other currency. So we think that the DFB Loan Stocks were qualifying corporate bonds so that losses on them are not allowable losses.

I've heard that I can get loss relief for loans to traders which are irrecoverable?

Subject to certain conditions an individual who has made a simple loan to a trader may be able to claim a capital loss, if at the time the claim is made any outstanding balance of the loan has become irrecoverable. This does not apply to debts which are a debt on a security such as the DFB Loan Stocks or to amounts which can be taken into account in computing income. Such a loss may be clawed back if the debt is recovered or is satisfied by the receipt of an asset.

More detailed information is available in our Capital Gains manual at CG65930 onwards.

We understand that any outstanding balances on member's Investment Account, Liability Loan Account and Capital Account loans were fully satisfied by the issue of shares on 27 March 2009. The loans did not become irrecoverable and no relief is available.

What about my £5 Ordinary shares?

Losses on these shares will be allowable losses.

Find out more about calculating losses on shares

What about my 'B' shares?

Losses on these shares will be allowable losses.

Find out more about calculating losses on shares

What about my 'A' Ordinary shares?

Losses on these shares will be allowable losses. The amount of the loss will depend on whether you received the shares in exchange for Preference Shares or in satisfaction of a balance on your Member's Liability Loan, a Member's Capital Account or a Member's Investment Account. If you gave your Preference Shares for them then the cost which you deduct to arrive at the loss will be the cost of those preference shares. If they were received in satisfaction of the debts represented by the Loan, Capital or Investment accounts then the cost which you deduct is limited to the market value of the 'A' Ordinary shares at the time they were issued to you - this may well be nil (it is not the amount of the debt).

Find out more about calculating losses on shares

What about the balances on my Member's Liability Loan, Member's Capital Account or Member's Investment Account?

All these debts were 'cleared' on 29 March 2009 when DFB issued 'A' Ordinary shares in satisfaction of them (see above for treatment of losses on those 'A' shares)

Are you sure about all this?

HMRC has considered the available evidence carefully and applied the relevant statute to the facts as they appear to us. The documents we have seen are listed in Appendix A to this note. If you have any other documents which may alter our understanding of the facts of the case, in particular by shedding a different light on the precise nature of any of the various classes of debt owed by DFB to its members, we should be pleased to consider them and if appropriate to revise our views.

How do I go about claiming my losses?

You will have to claim losses on the appropriate pages of your tax return. You will need to supply a computation which shows the proceeds (if any) from the disposal of the shares or debt and the amount deducted on account of the asset's cost. If you have not physically disposed of the asset, but you think it has become of negligible or nil value, you will need to explain this to us and make a claim to that effect.

Find out more about making a Negligible Value Claim

Appendix A

Documents seen by HMRC

Basic guide to DFB capital structure and associated issues (September 2004; two pages)
Members' Financial Agreement (undated copy: April 2006)
Members' Financial Agreement - Summary Sheet (undated; two pages)
Letter to members dated 5 March 2009 headed 'Capital structure'
Letter to members dated 1 April 2009 headed 'Capital structure developments'
Notice of Special Council Meeting to be held on 27 March 2009
Council Explanatory Notes (undated; two pages eight headings)
Minutes of the Full Member Council Meeting on 27 March 2009
Member Capital - Information Sheet (dated April 2009; two pages plus a table listing and describing DFB's issued shares and debt instruments
Briefing Note describing members' capital structure and the changes introduced October 2007 and amended in January 2008 (March 2008 - six pages)
 

The following additional documents were supplied by the Receiver on HMRC's request:

List of 'Members' Investments in Dairy Farmers of Britain Limited' prepared by BrookStreet des Roches LLP (Registrars) on 11 December 2009 (Note: circulation to third parties allowed for information purposes only).
New Rules of Dairy Farmers of Britain Limited (92 pages; includes partial amendments registered by the FSA on 9 April 2009).
Four and twelve month Member Contracts between DFB and members.

Appendix B

Summary of the potential capital loss position for each category of share and debt.

Type of share/debt Simple Debt Debt on a Security Qualifying Corporate Bond Allowable Losses
Ordinary Shares n/a n/a n/a Yes
'A' ord. shares n/a n/a n/a Yes*
'B' ord. shares n/a n/a n/a Yes
Preference Shares n/a n/a n/a Yes
Loan Stocks** No Yes Yes No
Member's liability loan Yes No No No
Member's capital account Yes No No No
Member's investment account Yes No No No

* The amount of the loss may be nil dependent upon the type of debt that was converted into 'A' shares

** Loan Stock 2012, 2014, 2015, 2016, 2017 and 2018.


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© Crown Copyright 2010.

A licence is need to reproduce this article and has been republished for educational / informational purposes only. Article reproduced by permission of HM Revenue & Customs under the terms of a Click-Use Licence. Tax briefs are updated regularly and may be out of date at time of reading.



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Article Published/Sorted/Amended on Scopulus 2010-01-19 15:26:27 in Tax Articles

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