Refinancing existing debt - wholly and exclusively for the purposes of the trade?
03 November 2008
An individual lender or guarantor of a "qualifying loan" to a UK resident trader can, where that loan has become irrecoverable, be treated as having made an allowable loss for capital gains tax purposes under section 253 TCGA 1992. One of the key conditions for claiming this relief is that the money lent must be used by the borrower 'wholly for the purposes of a trade carried on by him'.1
In Robson v Mitchell (Inspector of Taxes)  STC 893 a single member company had performed work on a property owned by its sole shareholder/director (the "taxpayer"). There was no evidence to suggest that the work was carried out on a commercial basis. By 1993, the company had an overdrawn account with its bank, and it refinanced its existing borrowings with a term loan from the bank secured and guaranteed by the taxpayer.
In 1994 the taxpayer sold another property, realising a chargeable gain, and used some of the proceeds of sale, roughly representing the amount of the chargeable gain, to reduce the company's indebtedness to the bank. The taxpayer sought to set this payment against the capital gain on the sale of the property on the basis that it was a "qualifying loan" for the purposes of section 253.2
There was insufficient evidence before the General Commissioners to support a finding that the original overdraft spent on the taxpayer's property was wholly for the purposes of the company's trade. Instead they found that the company's borrowing involved an element of benefit to the taxpayer. They also found that the loan was intended to replace the overdraft.
The General Commissioners rejected the taxpayers claim for relief under section 253, and this was upheld by the High Court. On appeal to the Court of Appeal, the court rejected the taxpayer's contention that the purpose for which the overdraft was spent was irrelevant for section 253 so long as the loan taken out to refinance the existing debt could be said to be 'wholly for the purposes of the company's trade'.
To determine whether a loan taken out to refinance an existing debt represents a "qualifying loan", the purpose for which the original borrowing was incurred had to be assessed.
Where money lent was used to repay an existing indebtedness, the purpose served by the use of that money was characterised by the purpose of the existing indebtedness. Thus where money lent was actually used for a wholly trading purpose, the taxpayer was not precluded from relief where he simply wanted to refinance the loan. On the other hand, a non-qualifying loan could not be converted into a qualifying loan by a refinancing exercise.
The immediate lesson to be gleaned from the case relates to individuals guaranteeing company finance. To the extent that they wish to claim the relief in section 253, they must be in a position to demonstrate, by reference to adequate records and the arrangements in place, that the loan to the company was in fact wholly for the company's trading purposes rather than for the benefit of a majority shareholder.
But apart from the immediate lesson, dicta in the case provide some welcome authority on a point which has, to date, been difficult to come by from the higher courts. Namely, on the question of whether interest payments on loans taken out to refinance a trader's existing borrowing qualify as deductible expenditure for income and corporation tax purposes.
Following Robson, it is reasonably clear that so long as an interest expense incurred on some original borrowing was wholly and exclusively for the purposes of the trade,3 so will the interest expense on any loan taken out to refinance the existing borrowing, all other things being equal.
1 Not being a trade which consists of or includes the lending of money. The debt in question must also not be a 'debt on a security', which is broadly one that is designed to be capable of being sold at a profit, for instance a fixed interest bond (see for discussion Aberdeen Construction Group Ltd v IRC  STC 127).
2 Cf. section 253(4).
3 Cf. section 34 ITTOIA 2005.