CVA Debt Write-offs and Tax: Understanding Loan Relationship Rules

Understanding CVA debt write-offs and tax

Corporate debt in the UK is taxed under special legislation known as loan relationship rules. This legislation, originally introduced by the Finance Act 1996, was eventually incorporated into the Corporation Tax Act 2009.

So what exactly is a ‘loan relationship?’ The term is defined in the legislation as follows:

“For the purposes of the Corporation Tax Acts, a company has a loan relationship if:

(a)the company stands in the position of a creditor or debtor as respects any money debt (whether by reference to a security or otherwise), and

(b)the debt arises from a transaction for the lending of money.”

In order for a loan relationship to occur, both of these conditions must exist, but further rules now apply when a company enters into a Company Voluntary Arrangement, or CVA.

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How does a Company Voluntary Arrangement work?

A licensed insolvency practitioner (IP) is appointed to administer the Company Voluntary Arrangement, which is designed to allow directors to trade their way out of difficulty. The company may have suffered an unexpected downturn in trade but must be viable in the long-term.

The IP presents a proposal to creditors for repayment of part of their debt – for example, 40p in every pound owed. If the creditors approve the proposal, they’re agreeing to 60% of their debt being written off at the end of the CVA term.

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What happens when debts are written off under a CVA?

A debt is released, or written off, when a creditor relieves their debtor of the duty to repay. Under normal conditions, a credit would appear in the debtor company’s books as an exceptional item in the profit and loss account.

As such, it would become taxable under the loan relationship rules. When a company enters a statutory insolvency procedure, however, an exception to the loan relationship rules may be made in certain circumstances.

Not assessable for corporation tax

Because the credit has resulted from a statutory insolvency procedure - a Company Voluntary Arrangement (CVA) - an exception is made to the loan relationship rules. The percentage of debt released as a result of the CVA becomes part of the distressed company’s revenue reserves, but crucially, doesn’t become assessable for corporation tax.

If this exception didn’t apply, the ensuing tax charge – a potentially significant sum - could have a severely detrimental effect on the company’s financial situation and general recovery at the end of the CVA term. In effect, it could potentially reverse any trading improvements made over the previous five or six years.

If your company is experiencing financial decline and you’re concerned about insolvency, our experts at Real Business Rescue can provide professional guidance and support. We’ll establish the company’s current financial position, and advise on the most suitable options. Call one of the team to arrange a free same-day consultation - With nationwide offices stretching from Inverness down to Exeter, Real Business Rescue can offer unparalleled director advice across the UK.