HMRC sets one-year permanence test for debts on securities

Whether a loan is a debt on a security decides whether its disposal can produce a chargeable gainGOV. A disposal of a mere debt by the original creditor accrues no chargeable gainLegislation; a debt on a security is a chargeable assetGOV, so a gain on its disposal is chargeableGOV. In W T Ramsay Ltd v CIR the company had an agreed gain on a farm sale and built a scheme to manufacture an allowable loss, passing value from shares into a loan known as L2 and disposing of both. Had L2 been a mere debt, the gain on its disposal would not have been chargeable. The House of Lords held L2 was a debt on a security, the gain was chargeable, and the scheme failed.

The new guidance draws from the speeches of Lords Wilberforce and Fraser the essential feature of a debt on a security: marketabilityGOV. Lord Fraser put the distinction as one between a simple unsecured debt and a debt of the nature of an investment, which can be dealt in and purchased with a view to being held as an investment; Lord Wilberforce distinguished mere debts, which normally do not increase but may decrease in value, from debts with added characteristics enabling them to be realised or dealt with at a profit. Two conditions follow, and both must be satisfied: the debt must be capable of being held as an investment, and of being realised at a profitGOV. A debt that looks like a good investment but cannot be realised at a profit is not a debt on a security.

To be held as an investment, the debt should carry a commercial rate of interest, carry a premium on repayment equivalent to the interest that would have been paid, or have been issued at a discount so that repayment at face value reflects that interestGOV. Where those markers are absent and the return is clearly uncommercial, debt-on-a-security status should not be accepted.

Realisability at a profit turns partly on the premium or interest rate, but also on the loan terms. Even a debt carrying an attractive rate may not interest a purchaser: if the borrower can repay early, the buyer must weigh whether the loan will last long enough to cover acquisition costs and still yield a worthwhile return. A loan repayable at short notice is not automatically excluded, but HMRC expects some compensation to the creditor for the uncertainty, such as a penalty on early repayment capable of turning an otherwise unattractive loan into a worthwhile investment. A short-notice loan with no compensating benefit counts against acceptance.

On permanence, HMRC adopts a one-year thresholdGOV: a loan which the borrower could not terminate within a year from commencement can be accepted as having the required structure of permanenceGOV, though no precise general limits can be set since attractiveness depends on the other terms and the market where the debt would trade. Conversely, a debt does not gain permanence merely because the borrower is not in a position to repay in the foreseeable future. Standard clauses accelerating repayment on events such as default or liquidation do not displace the stated repayment terms.

Legal basis: Taxation of Chargeable Gains Act 1992GOV, sections 132 and 251(1)GOV, as interpreted in W T Ramsay Ltd v CIR 54TC101GOV.