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HM Revenue and Customs Brief 05/10

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HM Revenue and Customs -Tax Authorities

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Issued 11 January 2010

Following the appointment of the receiver to Dairy Farmers of Britain (DFB) on 3 June 2009, HM Revenue & Customs (HMRC) were asked to comment on the tax position of the various types of shares, loans and debts held by members of DFB. We did this on 14 January in Revenue & Customs Brief 01/10 and this Brief clarifies certain points. Appendix C to this Brief updates and supersedes Revenue and Customs Brief 01/10.

Appendix A attached sets out the documents seen so far by HMRC. If any interested party has documents other than these which they feel may have a bearing on the matter they are invited to forward them to the address shown at the end of this note.

This note is a brief outline of what relief might be allowable for the purposes of Income Tax and Capital Gains Tax and Corporation Tax. This is summarised in Appendix B. Appendix C to this note sets out HMRC’s position in more detail. Where further information is required on general issues surrounding income tax or capital gains readers are invited to access this via the HMRC website or to seek advice from their professional adviser.

Income Tax

Members sold their milk to DFB and in accordance with the agreement between the two parties a fraction of the income earned by members was placed in Members Investment Accounts (MIAs). These were known as ‘milk retentions’.

Although the retentions were not paid directly to members, they were nonetheless income of the members, and should have been included in turnover when members prepared their annual financial accounts. Accounts approved after the appointment of the receiver need not include retentions in turnover. But financial accounts approved before 3 June 2009 cannot be reopened by reason alone of DFB going into receivership.

There is no scope in tax law for allowing capital losses against income.

Capital gains

Member’s ordinary shares, ‘B’ shares and preference shares in DFB are now of negligible value. Members will be able to claim capital losses equal to the cost of these shares when they are sold or deemed to be sold when a member makes a claim for negligible value. The ‘A’ shares issued on 27 March 2009 in exchange for debt might also attract capital losses if their cost is greater than nil, but from the information seen so far the cost would appear to be nil.

The debts that were converted into ‘A’ shares were the balances in members’ investment accounts (MIA) and capital accounts (MCA) at 27 March 2009. Further sums may have been credited to these accounts after that date and become irrecoverable. Provided they do not fall to be taken into account in computing income, members may be entitled to claim capital losses equal to these further sums. Any balances in the Member’s Liability Loan accounts not allowable in computing income might similarly qualify as capital losses.

Members may have held certain loan stocks in the company. The information held by HMRC suggests that the characteristics of the loan stocks mean that they were not chargeable assets for the purposes of capital gains so there can be no capital losses when the loans are disposed of. The amount of loan stock outstanding does not qualify as capital losses.

These tax implications are summarised in Appendix B.

Corporation Tax

Members who pay Corporation Tax may be able to claim relief for loans written off or reduced in value.

If you have documents (other than those listed in Appendix A) which may have a bearing on these matters, please forward them to:

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

Contents

Appendix A – Documents seen to date by HMRC

Appendix B – Table of tax impacts

Appendix C – Revised text of R&C Brief 01/10.

Appendix A

(this is the same as appendix A to Revenue & Customs Brief 01/10, published on 14 January 2010)

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

(this is a revised version of Appendix B to Revenue & Customs Brief 01/10, published on 14 January 2010)

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 Yes provided they were not involved in the share exchange and certain conditions are met.
Member's capital account Yes No No Only on balances arising after 27/3/09, if any
Member's investment account Yes No No Only on balances arising after 27/3/09

* 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.

Appendix C

Introduction

This is a revised version of Revenue & Customs Brief 01/10 (originally published on 14 January 2010). That brief is superseded by this Appendix. The revision is to take account of information that has come to light and to clarify certain matters. 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 beyond what is said below on losses arising to companies which are members of DFB, please contact the company's agent or the tax office which deals with the member company’s Corporation Tax affairs.

Income Tax treatment

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

Financial accounts approved before 3 June 2009 cannot be reopened by reason alone of DFB going into receivership and for financial accounts that cannot be reopened, the balance sheet will include the debt outstanding in respect of the milk retentions. The first financial accounts prepared and approved after the appointment of the receiver will no longer show the debt as it will either have been written down where the accounting date ended before 27 March 2009 or exchanged for ‘A’ shares if after this date. That debt will not qualify as a bad debt for the purposes of income tax as the debt was on capital account.

Corporation Tax treatment

Debts held by corporate members of DFB, for example limited companies, are dealt with under the rules for Corporation Tax rather than the rules for Income Tax and Capital Gains Tax. What follows is a brief guide to what relief, if any, might be available under those Corporation Tax rules.

Please note that the following guidance assumes that throughout the existence of DFB the corporate members were not connected to DFB as defined under the ‘loan relationship’ regime.

The tax position of each corporate member will vary depending on how they have treated the loans made to DFB in their (members) financial accounts. It may be that prior to the debt-equity swap some corporate members made provisions against or wrote off the DFB loans, in which case tax relief may have been obtained in the accounting period that the loan was written off or provided against.

In the case of a debt-equity swap a corporate member can get tax relief where as part of the swap the corporate member treats the debt liability as discharged. The creditor (the corporate member) is allowed relief for the amount released. For example, JH Ltd lends £100,000 to KF Ltd. KF Ltd gets into difficulties and JH Ltd agrees to accept 500 x £1 shares in full and final settlement of the debt. Because of the poor state of KF Ltd, these shares are only worth £1,000. JH Ltd can have relief for the amount released - £99,000, as an impairment loss but only in relation to the debt that was swapped, and only in the accounting period in which the swap took place.

Because a debt/equity swap involves exchanging a loan relationship (a qualifying corporate bond) for shares, there are chargeable gains implications. The debt-equity swap is likely to be treated as a reorganisation of share capital under the capital gains rules. Since the ‘old asset’ - the debt - is a qualifying corporate bond, and the ‘new holding’ - the shares – are not, the debt that has been swapped for shares is treated for loan relationships purposes as having been disposed of for its market value and from what we have seen is likely to be, or to be close to, zero.

The remaining part of this Appendix concentrates on the position of individual, rather than corporate, members and it should not be assumed that the treatment of individual members will be the same as the treatment of corporate members in similar circumstances.

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 wish, you may therefore make a 'negligible value claim' and claim a capital loss on the shares even though you still own them.

Read more about Capital Gains Tax

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. In order to make a negligible value claim and hence generate an allowable loss, the ‘A’ Ordinary shares must have become of negligible value since you acquired them. This means that they must have been worth something when you got them. HMRC’s view is that the shares appear to be of very little value when they were issued - albeit that in due course formal valuations may be in point - and so a negligible value claim, if possible at all, is likely to produce only a small allowable loss. If you have evidence to the contrary, please send it to the address at the end of this note.

In order to compute the amount of any loss on shares, you must establish their allowable cost. To do this correctly, 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 ‘debt on a security’. We explain this in more detail below.

Losses on disposals of debts are not usually allowable unless either (one) you acquired the debt from someone else or (two) it is what is known as 'a debt on a security'. (But even if it is a debt on a security, losses will still not be allowable if it is also a qualifying corporate bond - see below). If a debt does not fall into either of these two classes then it is called a 'simple debt'. A simple debt is exempt from Capital Gains Tax and so any losses are not allowable. Where a simple debt has not been disposed of, but has become irrecoverable, even if you are the original creditor it might still be possible to claim an allowable loss in respect of the outstanding balance. This is relevant to the tax treatment of the balances on Members’ Liability Loan Accounts, Members’ Capital Accounts and Members’ Investment Accounts’

In contrast whether a ‘debt on a security’ is chargeable depends on the terms and circumstances of its issue. This is relevant to the tax treatment of loan stock. To be a ‘debt on a security’ the debt must be capable of being held as an investment and relevant pointers are the potential for appreciation and depreciation in value, the existence of other actual or potential yield on the debt and the terms on which the creditor can realise the value of their debt by redemption or disposal to a third party. Where a ‘debt on a security’ is a normal commercial loan, it is expressed in pounds sterling, and there is no provision within the agreement for conversion into or redemption into a currency other than sterling, it is known as a ‘qualifying corporate bond’

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. Neither is there any provision for allowing losses when the debts on qualifying corporate bonds become irrecoverable.

See the sections on Loan Stock and Members’ Liability Loan Accounts, Members’ Capital Accounts and Members’ Investment Accounts below for details of how these debt rules might apply to your debts with DFB.

DFB's debts

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 by HMRC on how the tax rules will apply to the shares and debt has to be based on the facts and these 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. 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.

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.

Members’ Liability Loan Accounts, Members’ Capital Accounts and Members’ Investment Accounts

The information shown in the documents clearly suggests that these are simple debts. Losses on their disposal are therefore not allowable losses. However, provided certain conditions are met, if these loans have not been disposed of then it may be possible to claim capital losses equal to any outstanding balances which have become irrecoverable and which may not be taken into account in computing income.

Members’ Investment Accounts

We now understand that, although the balances in the Members’ Investment Accounts were disposed of when they were exchanged for ‘A’ shares in March 2009, further indebtedness may have arisen as a result of sales by members to DFB after that event. If those later debts have not been disposed of but have become irrecoverable then if, exceptionally, any amounts do not fall to be taken into account in computing income it may be possible to claim an allowable capital loss. The loss is equal to the outstanding amount of those later debts which has become irrecoverable and which is not allowable in computing income.

Members’ Capital Accounts

We understand that the balances in the Members’ Capital Accounts were disposed of when they were exchanged for ‘A’ shares in March 2009 and no further amounts were credited after that date. The debts represented by the balances in the Members’ Capital Accounts were disposed of on 27 March 2009 and because they were simple debts no allowable loss arose. It is possible that a different loss arose later in respect of the ‘A’ shares received: see the paragraph on ‘Conversion of debt into 'A' Ordinary Shares’ below.

Members’ Liability Loan Accounts

It would appear that the balances in the Member’s Liability Loan accounts were not involved in the exchange for ‘A’ shares. If any balances in the Members’ Liability Loan Accounts have not been disposed of and have become irrecoverable then an allowable loss may be claimed equal to any amount outstanding which has become irrecoverable and which is not allowable in computing income.

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 but in order for you to be able to make a negligible value claim, and thus claim an allowable loss even though you still own the shares, they must have become of negligible value since you acquired them. If you make an actual disposal of the shares then you will be able to claim any loss which arises on the disposal. In either case, the amount of the loss will not exceed 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 allowable cost cannot exceed the market value of the shares at the time they were issued. We think that the market value of the shares will be the same as the value of the debt at the time of the exchange, and from what we have seen that figure is likely to be, or to be close to, zero. The same will apply if the debt was both a debt on a security and a qualifying corporate bond.

The debts which were converted into 'A' Ordinary shares were the Members’ Capital Accounts and the Members’ Investment Accounts. These debts, as mentioned above, were simple debts and so the cost of the 'A' shares will not be greater than their 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. However if any member or interested party has documentation that would suggest that the ‘A’ shares had a positive value at the time they were issued, or that the debts may have had a value at 27 March 2009, HMRC would be pleased to review this to see whether it could agree that the debt, or the shares, had a value greater than £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 members may be entitled to income tax relief for trade debts (such as outstanding milk cheques) gone bad and for some milk retentions credited to their Members’ Investment Accounts, dependent on when financial accounts were prepared and approved.

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, the 'A' Ordinary shares received in exchange for Preference Shares and – in some rare circumstances - in respect of milk retentions credited after 27 March 2009. Balances in the Members’ Liability Loan Accounts may also give rise to allowable capital losses if they have become irrecoverable and if they are not allowable for the purposes of income. Losses have to be claimed.

Appendix B sets out in tabular form the approach that will apply to the various shares and debts.

This updated note contains HMRC’s views on the information and documents made available to us. 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’s 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?

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. You will also be entitled to exclude from the figure of turnover in financial accounts that were approved after the appointment of the official receiver any milk retentions that were credited to your Member’s Investment Account (MIA) after the accounting date of the latest approved financial accounts.

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.

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.

We understand that although the outstanding balances on a member's Investment Account and Capital Account loans were fully satisfied by the issue of shares on 27 March 2009 further balances may have arisen after that date. These later sums may have become irrecoverable, and it might thus be possible to claim capital losses equal in amount to those later balances if, exceptionally, they are not allowable for the purposes of Income Tax. Members will also be in a position to claim capital losses on the balances in Member’s Liability Loan Accounts provided they were not involved in the exchange for shares, were irrecoverable and were not allowed for the purposes of Income Tax.

More detailed information is available in our Capital Gains manual at CG65930 onwards. Please see also the earlier section on the Income Tax treatment.

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 Capital Account or 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 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. (The market value of the shares may prove to be the same as the value of the debt given for them, but given the circumstances of DFB at the time that is unlikely be the face value of the debt – see the notes above under ‘Conversion of debt into ‘A’ Ordinary shares’).

Find out more about calculating losses on shares

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

All these debts were 'cleared' on 27 March 2009 when DFB issued 'A' Ordinary shares in satisfaction of them (see above for treatment of losses on those 'A' shares). For milk retentions credited after that date which have become irrecoverable, members will be entitled to claim capital losses if, exceptionally, the retentions are not allowable in computing income. We understand no sums were credited to Members’ Capital Accounts after 27 March 2009.

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. 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 or their value at the time they were exchanged for ‘A’ Ordinary shares, 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


About the Author

© Crown Copyright 2010.

A licence is needed 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 2010-02-19 21:11:58 in Tax Articles

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