P2P Bad Debt Relief Post Publication of final guidance

Comments on final guidance www.gov.uk/government/publications/income-tax-relief-for-irrecoverable-peer-to-peer-loans-final-guidance

Edit 19/9/16:  The Finance Bill received Royal Assent on 15 September.  The relevant provisions are unchanged and are now the law.

SAIM 12030 When is tax relief available?

Some key points:

• The loan must be through a regulated platform ("operator") with permission under Part 4A of FSMA 2000.  I believe that this includes interim permission.
• Operators with "equivalent permission" elsewhere in the EEA are also OK.  Hopefully someone will have a list.
• It applies to loans made at any time that become irrecoverable on or after 6 April 2015.  I will come back to that.
• It will be available to individuals who are subject to UK income tax on their loan income.
• Other types of UK income tax payer may be eligible, subject to conditions, but discretionary trusts are not (see SAIM 12070 on page 11 of the guidance).
• It will not be available to UK corporates, who may instead be able to claim for losses under the loan relationships regime (no change there).

SAIM 12040 What loans are eligible for the relief?

Some key points:

• Loans must be on normal commercial terms and not made for the purpose of obtaining a tax advantage.
• The lender must be subject to tax on the income, so loans held within an ISA are not eligible.
  
• Loans by individuals are not subject to the £25,000 limit, which was worrying a few people.
• Where the £25,000 limit does apply, it applies only to P2B lending, not P2C.

SAIM 12050 When is a loan treated as irrecoverable?

The word "irrecoverable" is not defined in the legislation, so we have to rely on the guidance alone.  This is better than it was but it still requires a lot of interpretation.  I will quote it in full and then say what I think it means:

"When does a peer to peer loan become irrecoverable

A peer to peer loan may be accepted as having become irrecoverable when there is no reasonable prospect of the recovery of the loan. When assessing recoverability, the funds available and potentially available to the borrower must be considered. A claim therefore cannot be established simply because the borrower has insufficient liquidity on the date the loan had been called in.

Whether a loan has become irrecoverable should be judged on a case by case basis, however as the loan will be managed by a platform, the platform would usually be in a position to determine when a loan has become irrecoverable. The platform would then inform the lender that the loan had become irrecoverable.

If the platform does not undertake this action, then the lender may still determine that the loan has become irrecoverable. However it will be the responsibility of the lender to show that there is no reasonable prospect of the recovery of the loan and it is NOT simply a case of late payment.

When is a peer to peer loan treated as irrecoverable?

Under the legislation for income tax relief for irrecoverable peer to peer loans in certain circumstances a loan may be treated as irrecoverable for the purposes of the relief even if there may be a prospect that the lender could recover some of the amount outstanding.

This is the case for the following situations:

Loans with security
When loans are made against security, a loan may be treated as becoming irrecoverable as if the security did not exist.

Loans where legal recovery action is taken
When the borrower has entered legal recovery procedures such as liquidation, administration, receivership or bankruptcy the loan may be treated as becoming irrecoverable as if such action was not available.

Subsequent Recoveries

If a loan has been treated as irrecoverable in either of the scenarios outlined above then the relief will be given at the point where the loan becomes irrecoverable other than for the specified recovery actions.

If any value is then recovered, either through these actions or by any other means, then this recovery would then be taxed as additional interest received by the lender.

This is the same treatment as any other subsequent recovery of a relieved irrecoverable loans (more detail in Subsequent recoveries [SAIM 12200, see later]."

The guidance seems to be drawing a distinction between loans becoming irrecoverable (the first three paragraphs), and being treated as irrecoverable (the rest).

• A loan will become irrecoverable only if there is no reasonable prospect of recovery - a pretty tough test, particularly if "irrecoverable" is interpreted to mean wholly irrecoverable, which seems to be HMRC's interpretation (see SAIM 12060 below)
  
• However, it may be treated as such, if it would be irrecoverable but for the enforcement of security or a legal recovery procedure such as liquidation, administration, receivership or bankruptcy.  In this case, relief will be given at this point and reversed in the event of a subsequent recovery.
  

I think the likely effect of this guidance for P2B loans is that, in most cases, relief will given when the security is enforced or the legal recovery procedure commences.  This is because such action will (or should) take place as soon as the platform decides that, without it, there is no reasonable prospect of recovery.  I have no experience of losses on P2C loans (mine are all on RS with the benefit of a provision fund) so can't comment on how it might work there.

Note the central role attributed by HMRC to the platform in determining when a loan has become irrecoverable.  If lenders are looking to claim a loss that has not been notified by the platform, the burden of proof will be on them.  Platforms will certainly have to do the work from 6 April 2016, because the automatic relief will rely on it.  However, it is less clear what will happen for losses arising between 6 April 2015 and 5 April 2016 and it will be interesting to see how the platforms approach this.

A key point to consider will be the how the cut-off works for loans that were in difficulty prior to 6 April 2015 but have only been written off (if at all) subsequently.  Many of these would have been eligible for the "treated as" relief prior to that date.  Does this mean that lenders cannot claim a loss for them?  My first thought was to I would argue that:

• the "treated as" relief is permissive, not mandatory (the guidance says "may");
• therefore lenders do not have to take it and can instead claim a loss on the strict arising basis, when the loan has become irrecoverable;
• hopefully this will be after the cut-off date.]

Unfortunately the legislation itself is not drafted like that.  There is just a single test:

• Under s412A(1)(d), relief is given when "any outstanding amount of the principal of the loan has, on or after 6 April 2015, become irrecoverable";
• s412A(8) goes on say "In this section 'irrecoverable' means irrecoverable other than by legal proceedings or by the exercise of any right granted by way of security for the loan"

Which makes it pretty clear that if loans were in sufficient difficulty to have qualified for relief on a "treated as" basis prior to 6/4/2015 they will not be eligible for the new relief.  Lenders will instead be left to make a capital loss claim, if this of any use to them, once the loan is actually irrecoverable.

Another important point is that the legislation refers to "any right granted by way of the security".  I think this requires "security" to be understood as referring to the security right, not the asset(s) over which the security is given.  These are two different things:

• Example 1: Loan to company secured on its debtors. The debtors are assets of the company and you cannot pretend that they don't exist. The company remains obliged to pay you, by realising the debtors itself if necessary. I don't think the existence of the security brings forward the date on which relief can be claimed, relative to a similar loan to an identical company without the security.
  
  
• Example 2: Loan to company secured on the director's house. Because the house is not an asset of the company, you CAN claim relief if the only way you will recover the loan is by going after the house. To the extent that you are successful you then have to repay the relief.

Loans to companies secured on property will generally fit example 1. There may be additional security outside of the company (such as a PG) but the primary security is over the company's assets.

Many platforms appear to have asked themselves whether the loan would be irrecoverable if the assets over which the security was given did not exist. The answer to that question is invariably yes, leading to the conclusion that the loan should be treated as irrecoverable as soon as legal recovery commences. The question they should have asked (in my opinion) is whether the loan would be irrecoverable if the security over the company's assets did not exist (so that the only way to recover would be by going after any additional security outside of the company). The answer to that question, for loans to companies secured on property, will usually be no.

To expand/explain further:

• "Irrecoverable" means (essentially) wholly irrecoverable.
  
• I think "treated as irrecoverable" must be interpreted consistently, as "treated as wholly irrecoverable". This is consistent with what AC have done.
• But a loan to a company secured on its assets is unlikely to be wholly irrecoverable (but for legal action or exercise of the security) unless those assets are worthless or there are prior charges or there is some other very particular problem.

It has to be said I'm not aware of any platform doing it the way I think it should be done (though I'm not on many).  The HMRC guidance is largely to blame for that, by failing to pick up the precise words of the legislation.  But I intend to follow the letter of the law for my own returns, at least for property loans where I think it is plain wrong to claim before a loss is actually crystallised.

SAIM 12060  Transfers of irrecoverable loans

Some key points:

• There is no relief for assignments or sales at a loss.  HMRC comments "If the lender is able to assign or sell a loan for consideration then the assumption would be that the loan has some market value and is not irrecoverable", which suggests HMRC interprets irrecoverable to mean wholly irrecoverable.
  
• If the loan has already been treated as irrecoverable, the lender will have got relief at that point.  In this case any proceeds of sale or assignemnt are taxed as a subsequent recovery.
• The person who acquires a loan on which relief has already been given (because treated as irrecoverable) will not be eligible for loss relief.

Based on the last point it will be important for buyers to know whether relief has been given in the past - which would be fine if this was wholly under the control of the platforms, but it is not.  Having said that, I have no idea how HMRC would know if a specific buyer had purchased a loan for which the specific seller had already claimed relief, unless the relief was one notified by the platform.

It should be noted that on many platforms, including AC and FC, "sales" of loans are not legally sales at all, but redemptions funded by a new issue of debt.  The guidance does not address the position of the "seller" or the "buyer" in these transactions but I think the tax outcome will be the same.

SAIM 12070  Who can receive the relief?

The claimant must be the legal owner, or the loan can be held by a nominee or bare trustee on their behalf.  Discretionary trusts cannot claim the relief.

SAIM 12100 - 12140  Calculating the relief

Some key points:

• Relief is calculated by reference to the lower of the principal lost (or treated as lost) and the amount paid
  
• It is given first against interest income on the same platform for the same tax year.  This is automatic from 6/4/2016, but for the previous year it will require a claim on the tax return
  
• Any remaining losses can be relieved against interest income on other platforms for the same tax year. Claim on tax return required.
• Unrelieved losses can be carried forward for up to 4 years against future p2p interest.  Again, a claim is required.  The time limit is disappointing.

SAIM 12200  Subsequent recoveries

If lenders receive a subsequent recovery in respect of a loan for which they have previously had relief, the recovery is taxed as P2P interest income up to the amount of the relief that the lender previously got.

One of the examples is of a lender, Lucy, who pays £10 for a loan with a principal amount of £15.  The principal is written off, giving Lucy relief of £10 (limited to what she paid), then subsequently recovered, giving Lucy p2p interest income of £10 in respect of the recovery.  The guidance goes on to say:

"The additional £5 that Lucy receives above what she paid for the loan is taxed in the same way as it would have been had the loan been repaid in full and on time."

Which is not especially helpful.  If Lucy was the buyer of a second-hand debt (as I believe to be the case on TC), I think the £5 gain is liable to capital gains tax, subject to the annual exemption.  If Lucy's debt was in legal form a new debt (as on AC, FC and some other platforms), I think the £5 is a tax nothing and there is no tax to pay on it.

SAIM 12210  Interaction with capital gains tax

Some (mostly P2B) loans have been historically eligible for CGT loss relief.  According to the guidance, from 6 April 2016 this will no longer be the case.  I don't think that's quite right.  The reason given in the guidance is that "Section 2(3) of TGCA 1992 specifically gives priority to income tax reliefs".  What the relevant section actually says is "...loss... shall not be allowable as a deduction from chargeable gains ... if and so far as relief has been or may be given in respect of it under the Income Tax Acts". So if a loss is not eligible for the new relief it should be eligible for the old one.

For example, an entity such as a discretionary trust, which is not eligible for the new relief, will still be eligible for the old one where the relevant conditions are met.  More importantly perhaps, I think that a loan which is not eligible for the new relief (because it met the conditions for the new relief prior to the cutoff date of 6 April 2015), should continue to be eligible for the old relief.

For losses arising between 6/4/2015 and 5/4/2016, the old CGT relief will continue to be available if the new relief is not claimed.

Edit 6/4/2016:  I have changed my view (not in a good way) on the treatment of losses on loans which became irrecoverable, other than by legal proceedings etc, prior to 6/4/2015.  See amendments in dark red.

Edit 5/12/2007 (with apologies for not adding this before):  I have added my view that losses should not be claimed on loans secured on assets of the borrowing entity, unless those assets are worthless.  See amendments in green.  The additions are based on this post: p2pindependentforum.com/post/218979/thread.  You will see from the thread that not everyone agrees with me!

In 2016 I have £5000 invested in Bestbananas Ltd on Bassetz Capital P2P.com. Goes pop owing me £4000. I claim a loss of £4000 from my overall P2P £20K interest for the year. Result, 20% of £4000 tax reduction = £800 recovery, overall loss of £3200

In 2016 I have £5000 invested in Bestbananas Ltd. on Bassetz Capital P2P.com IFISA. Goes pop owing me £4000. I cannot claim a loss on my overall P2P £20K interest because the loss was on an investment not liable for tax, so I wouldn't have had to pay any. Result overall loss of £4000.

Or, has someone seen in the small print that the rule that you can't claim only applies if you have no non IFISA P2P interest from which to offset the loss?

Plenty of time to discover the answer, I think.

OG.


Edit: may it be that we should not put risky loans (higher rate) in our IF ISAs, just "safer" slightly lower rate loans?

5k, brackers, 5k!

Yes, not having loss relief in an ISA is the trade off for not being taxed on the income.  Other things being equal you'd hope the income exceeded the losses, and you'd also hope that the "expected return" on a diversified portfolio of risky loans was higher than on a diversified portfolio of safer loans, otherwise why take the risk? 

So there's no particular reason to favour "safe" loans for the ISA.  If anything, the reverse.   However, you could be unlucky!

Here's what to do in the 2015/16 tax return since it's about to be relevant for those who get in early:

"6 April 15 to 5 April 16

The Lender can also claim relief on P2P loans that became irrecoverable on or after 6 April 2015 against other interest received in the same tax year from other P2P loans that were made through the same platform as the now irrecoverable loan.

This relief should be claimed in a tax return.

In order to claim relief in a tax return the lender should deduct their available relief from the P2P interest that they have received in that year before entering the figure in their tax return."

It then goes on to say that it can be deducted from other platforms' interest if the first one doesn't have enough interest to use it all.

At least the claiming part is easy even if the deciding what to claim is harder. I'll be using reasonable estimates and rules since I don't expect most of my losses to be reported by the most significant platform I use in this area, Bondora.

"SAIM 12060 Transfers of irrecoverable loans"
... the not too relevant to this post bits about selling at a loss ...

"in some cases a loan may become treated as irrecoverable, and the lender may then transfer the loan to a recovery agent in order for legal proceedings to be taken.

For example, the loan may be identified as becoming irrecoverable other than by legal proceedings or by reference to security whilst it is are in the hands of the lender. Once the loan has been identified as irrecoverable, the lender may then assign the loan to a recovery agent to take further  action.

In this case the loan would be treated as irrecoverable whilst it is are in the hands of the lender, and  the lender would be eligible for relief. Any recovery that the lender subsequently receives from that loan, whether through the recovery agent or from anywhere else, will be brought into charge as a subsequent recovery."

That might actually be sensible good news, since it appears that HMRC might be recognising that at some point once debt collection agencies are called in after a default the loan should be treated as irrecoverable, particularly if legal proceedings are commenced. Immediately wouldn't make a lot of sense unless legal proceedings are commenced immediately because sometimes a DCA will get a payment through chasing the borrower, not legal action. Assuming of course that "recovery agent" includes DCA not just bailiff or solicitor.

Different platforms have different debt collection policies so the time would differ for each. For example, Bondora has now started sending in DCAs even without a default if a payment is a week late and that definitely would not be appropriate because there's ample reason to expect recovery. Yet if a DCA has failed to get any collection after a default for thee months Bondora would try a second DCA. Then a third. Then potentially go on to legal action, or not, at their discretion (based on cost partly, to them), at least nine months after default. Somewhere in that spectrum it would seem reasonable to conclude that the loan is not going to be recoverable on a pragmatic basis without legal action.

The text "other than by legal proceedings" is interesting because it's linked to examples that include liquidation, administration, receivership or bankruptcy but not the more banal things that apply to consumers like insolvency due to DRO or IVA usually with partial capital loss, nor CCJ.