FK Investor Update - Tax Treatment of Losses

The guidance from the platform is
once there is no reasonable prospect of the recovery of the loan from the borrower.
which ain't the same thing as potentially unrecoverable

I would take my guidance from the platform .  Anyway you're lucky, this only came into force in France for loans which go bad after 1 jan 16

Ultimately one needs to rely on the legislation (still the Finance Bill at the moment). This grants relief when a loan has become irrecoverable on or after 6 April 2015, and defines irrecoverable to mean "irrecoverable other than by legal proceedings or by the exercise of any right granted by way of security for the loan."

Two key points from the definition, which do not come out clearly in the guidance:

Re security - You do not disregard the underlying asset(s), you merely assume that the right to exercise the security is not exercised. This will give a different answer in some cases.

Re legal recovery - The legal proceedings exception applies in all cases, not only after the proceedings have been entered into.

I would add that the definition does not permit you to disregard completely the ability to enter legal proceedings or to exercise security rights.  The ability to do these things, and the threat of doing so, is an important underpinning of the recoverability of any loan.  If the ability and threat are sufficient to make the borrower cough up without resorting to further action, the loan is not irrecoverable under the definition.

Please note, we have revised our understanding of the treatment of tax losses following further clarity received from HMRC.  

Since writing to you on the 4th April, we have received further clarification from HMRC about when loans are to be considered irrecoverable and therefore eligible for a tax relief claim. This has highlighted a mismatch on the definition of irrecoverable between the new rules for Income Tax and the existing ones for Capital Gains Tax.



This means that, based on the draft clauses in the Finance Bill, some of the information in our last email was incorrect.



What we said



In the last email we stated that each of the FundingKnight loans classed as “In Recovery” could be treated as irrecoverable and therefore investors are able to make a claim for loss against any or all of them for either Income Tax or Capital Gains Tax. This is wrong for two reasons.



Firstly, the proposed changes to the definition of when a loan becomes irrecoverable only apply to P2P loans for Income Tax purposes and not for Capital Gains Tax.



Secondly, the cut-off date for when a loan is treated as irrecoverable for Income Tax is only by reference to the borrower becoming unable to pay after 5th April 2015.



Clarification



Loans classified as “In Recovery” will be treated differently depending on the precise date when the original borrower ceased to be able to pay.



Where the borrower ceased to be able to pay or before 5th April 2015:



• A claim for loss against Income Tax is not possible.

• A claim for loss against Capital Gains Tax is only possible once all payments have stopped.



In practice if the only payments due are from an Insolvency Practitioner and it is expected that investors will get some pence in the pound, then it is usually acceptable to claim for the expected net loss. For example, if you are only anticipating 10p per pound, then a claim for 90% of the capital as a loss should be acceptable. If the final loss is different, then if you get back more the difference will be a capital gain (or a further capital loss if less).

Where the borrower ceased to be able to pay between 6th April 2015 and 5th April 2016:



• A claim for loss against Income Tax is possible. This must be made by the investor to HMRC.

• The Capital Gains Tax position is as above.



Where the borrower ceased to be able to pay on or after 6th April 2016:



• The loss is automatically considered irrecoverable for Income Tax purposes. The loss claim will, in most instances, be made by the platform (e.g. FundingKnight).

• Capital Gains Tax relief will no longer be available in most instances.



Some examples:



• Company A stops paying on 1st December 2014 and the guarantor takes over and is still paying



Date is before 5th April, so no Income Tax claim

Payments are continuing so no Capital Gains Tax claim


• Company B stops paying on 1st December 2014 and the guarantor takes over, but then also stop (and cannot continue)



Date is before 5th April, so no Income Tax claim

When all payments stop investors can make a Capital Gains Tax claim


• Company C stops paying on 1st May 2015 and all payments stopped before 6th April 2016,



Date is after 5th April, so investors can make an Income Tax claim

Alternatively investors can make a Capital Gains Tax claim


• Company D stops paying on 1st May 2015 and the guarantor takes over and is still paying



Date is after 5th April, so investors can make an Income Tax claim

As payments are continuing they cannot make a Capital Gains Tax claim


• Company E stops paying on 1st May 2016



FundingKnight will adjust the tax reports automatically to offset the loss against other income.

Any excess loss at the end of the tax year can be offset against other P2P income – this needs to be claimed manually

What happens now



We are now revisiting each “In Recovery” loan to determine the precise date that the original borrower ceased to be able to pay in terms of the Income Tax rules.



The rules are still awaiting final Royal Assent, which we expect in the coming weeks. Once this has been given we will provide affected investors with the precise information they will need for their tax returns.



Please accept my apology for any confusion we may have caused. 

Kay

In the current year example
Does one choose to offset against either Income Tax or Capital Gains as one feels fit?

Apologies for not coming back sooner - I have been out of the office.

Royal assent regarding the tax treatment of losses is still awaited.  We are working on the reports in readiness - I cannot confirm, at this stage, how the information will be presented but they will be in line with HMRC requirements.

Thank you for your query.

The Finance Bill received Royal Assent on 15 September. The provisions on income tax loss relief are unchanged.