CFM5149a - Taxing loan relationships: IAS accounts: incorrect accounting

FA96/S85A (2) - example

This guidance applies to periods of account beginning on or after 1 January 2005.

At the start of year ended 31 December 2006, a company makes a 5-year £10 million loan to an overseas subsidiary. The loan bears no interest for the first two years, but 8% interest is charged for the final three years. It is agreed between the company and HMRC that, overall, the loan is on arm’s length terms.

The accounts to 31 December 2006 do not bring in any interest on the loan. In the course of discussions with HMRC, the company agrees that this is incorrect and GAAP requires an effective interest rate method to be used to spread the interest receivable over the period of the loan. Regardless of the credits (or lack of them) in the accounts, the company’s CTSA return must be on the basis that the effective interest rate method had been used, and must bring in the appropriate amount of interest as a loan relationship credit for the year.

It is agreed that, on the basis of a computation of the effective interest rate, the company will bring in interest of £458,000 in year 1; £479,000 in year 2; £501,000 in year 3, £488,000 in year 4 and £473,000 in year 5.

In drawing up its accounts to 31 December 2007, the company starts to use an effective interest method, spreading the interest receivable in years 2 to 4 over the remaining period of the loan. The accounts show an interest credit of £600,000. But FA96/S84A (3) ensures that the company is only taxable on £479,000, not £600,000, even if the 2007 accounts are in accordance with GAAP.