BIM40265 - Receipts: unclaimed balances: trade debts written back to profit and loss account
To produce a true and fair view, modern accountancy practice requires that the write-back of trade debt must always be credited to the profit & loss account. Our view is that the profits chargeable to tax under Schedule D Cases I and II include the credit to profit and loss account of a trade debt write back. This interpretation was explained in an article in TB56/01 (December 2001). This guidance supersedes that article and explains our previous practice, which applied to accounting periods starting before 1 January 2002.
Accounting periods starting after 31 December 2001
You should not make a computational adjustment to the accounts of a trade, profession or vocation which show a credit to the profit and loss account for trade debt written-back unless the debt is released as part of a voluntary arrangement (see BIM42740).
A trade debt is a debt that has been allowed as a deduction for tax purposes. The trader (including those carrying on businesses or professions) has received goods or services and has a legal debt to pay for them. It does not include debts incurred for capital or non-allowable expenditure. Loan relationships of companies have separate legislation, which is explained in the Corporate Finance Manual.
Accountants may refer to trade liabilities or trade creditors and to the crediting of the profit and loss account rather than trade debt write-back.
ICTA88/S94 and release
ICTA88/S94 deals with the special situation where a debt is formally released. It does not apply:
- if there is no release, for example because creditor merely writes off the debt, fails to invoice or demand payment, or fails to present a cheque for payment; or
- if the release is part of a relevant arrangement or compromise (see BIM42740).
Section 94 provides that where a deduction has been allowed for a debt that is later released, the amount released is treated as a receipt of the trade, arising in the period in which the release is effected.
The ‘release’ of a debt must involve a contractual agreement. A debt is not deemed to be released because the debtor is bankrupt or in liquidation. Where the release is under seal no consideration is necessary. All other releases must involve the debtor giving consideration for the release. The consideration may be in non-monetary form, for example shares. A formal waiver of remuneration is also a release of a debt.
Intra-group debt may be released as part of a sale agreement involving a change of control of a company. These transactions usually have to be examined in detail to ascertain what amounts are trade debt and whether there has been a release.
Intra-group debt may also be released as part of a 'hive-across' within a group, where all the assets and liabilities of a company are transferred to another company within the same group of companies, and as a result:
- the transferee assumes the obligation to repay the creditor, and
- the creditor consents to release the transferor from its obligations in return for the transferee accepting them.
In this situation there is a release of a debt so Section 94 applies, but Case I principles also require the consideration given by the transferor to the transferee for accepting the liabilities to be deducted in computing profits which include any Section 94 receipt. The net result is that if full consideration is given (by transfer of assets), the Section 94 receipt is matched in full by the related deduction.
Particular circumstances of a release
Where the release occurs after the business has been discontinued (or treated for tax purposes as discontinued), the amount released is to be treated as a post-cessation receipt under ICTA88/S103 (see BIM80500 onwards).
A charge to tax should not be imposed when a debt is formally released if:
- a charge has already been made because the debtor’s accounts showed a write-back in the profit & loss account for the debt, and
- there have not been any intervening accounting entries reinstating the debt in the debtor's accounts.
Accounting periods which started on or before 31 December 2001
We no longer consider that the decision in the 1932 tax case British Mexican Petroleum Company Ltd v Jackson, (1932) 16TC570, is applicable in determining the tax treatment of trade debt written back. But our previous practice, based on that case, may be applied for periods before our change of view was announced:
- Where a trade debt is wholly or partly released by the creditor then ICTA88/S94 applies (see above).
- Where a trade debt is written back to the profit and loss account but is not released a tax computation adjustment should be made to deduct the amount.
British Mexican Petroleum Company Ltd v Jackson
Two trade debts were formally released in this case. Under the terms of an agreement with an oil producing company, British Mexican Petroleum Company Ltd was released from part of its trade debt for oil supplied to it. The amount released was carried direct to the balance sheet and shown as a separate item under the head ‘reserve’. The company was also released from a trade debt owing for ship charter hire and this sum was taken to its profit & loss account. It was only the taxability of the sum taken to reserve that was in dispute. The House of Lords decision was that the sum was not taxable.
Prior to December 2001, the Inland Revenue interpreted comments made in the House of Lords in this case to mean that write-backs of trade debt, apart from those brought into tax by ICTA88/S74, were not taxable. HMRC no longer consider this interpretation to be correct.
Health warning
This page is part of the section of the Business Income Manual on unclaimed balances. You should read the whole section to understand this topic: see the contents page at BIM40200.
