Wednesday, January 28, 2009



Imagine that you are the director of a property company. The company has £1.25m of bank loans and taking account of interest has a deficit on its balance sheet of £2.65m. The company has an option to buy a hotel, which it intends to turn into a block of flats. You register the company for VAT and opt to waive exemption. You exercise the option in March 2004 at a price of £15.5m plus VAT. You buy some adjoining land for £2m. You cannot raise the money for the development and on 1 April 2004 you sell the property for 17.7m plus VAT of £3.097m. In the quarter to 31 March 2004 you reclaim the input VAT, as the law requires you to do.

What do you do next? You know that you owe the bank £2.655m and at the end of July you will owe HMRC £3.097. If you use the input VAT recovered to pay the bank that would be a fraudulent preference. So would it be if you use it to pay HMRC.

Do you complete your VAT return and tell HMRC that you have no money to pay the amount shown as due? HMRC raise a computer-generated assessment and you pay that. How would you rate your chances of their not putting the company into liquidation?

The sensible thing is to consult an insolvency practitioner, which is what you do. On the advice of the insolvency practitioner you tell HMRC that that company cannot pay the VAT but you are expecting a profit on another development, which you hope will enable the company to do so in due course.

Would you be surprised if HMRC say that you have been dishonest, they want a 20% penalty which comes to £618,803 and that as you have been dishonest they have decided that the penalty ought to be paid by you personally?

Would you be more surprised if the VAT and Duties Tribunal were to say that, “We have accepted that at the beginning the Appellant had a genuine expectation of being able to pay the VAT out of other profits made by another associated company, this was looking doubtful by May 2004 and it is clear that this was not possible by September 2004. We have no doubt that ordinary people would regard this conduct as dishonest. It consists of deliberately keeping Customs in the dark about the amount of the liability for over seven months by the end of which it had become clear that the Company could not pay it”?
Whilst I do not of course condone what the director, Mr Conlon, did, I myself have strong doubts whether “ordinary people”, the “man on the Clapham omnibus”, would have regarded it as dishonest to keep Customs in the dark while he looked for a way to raise the money. I accept that “ordinary lawyers” probably would, but suspect that many “ordinary people” would have acted just as Mr Conlon did. After all there never was any money available to pay over the VAT and not selling the property would simply have made the company’s financial straits worse.

Monday, January 12, 2009



A small amendment hidden away in Finance Act 2008 can have nasty repercussions for anyone who has borrowed money for an allowable purpose on which the interest is payable in advance. The provision was tucked away at the end of a Schedule headed “Avoidance involving financial arrangements”. As neither of the opposition parties even asked about it during the Finance Bill debates, it presumably has all-party support.

Here is an example of the sort of tax avoidance that your MP apparently thinks is so wicked that tax relief ought to be restricted to punish people for entering into such transactions.


Jack took a mortgage of £200,000 on his house on 1 June 2008 from his friend Jill. Interest was payable quarterly in advance at 7%. Jack duly made his interest payments due of £3,500 each on 1 June, 1 September, 1 December and 1 March each year. He repaid the loan on 30 May 2010.


The interest paid on the loan was £14,000.
Interest at 7% p.a. on the loan for the period 1 June 2008 to 5 April 2009 (309 days) is £11,852. Accordingly there is an excess of £2,148, tax relief for which is blocked by section 384(2).


The interest paid on the loan is again £14,000.
Interest at 7% p.a. on the loan for the period 1 June 2008 to 5 April 2010 (674 days) is

The interest actually paid is £25,852
2008/09 14,000
Less excess 2,148 11,852
2009/10 14,000 25,852

Excess NIL

Tax relief is allowed on the amount of £14,000 paid in 2009/10


The interest paid on the loan is NIL
(the last interest due was paid on 1 March 2010)
Interest at 7% on the loan for the period 1 June 2008 to
31 May 2010 (730 days) is 28,000
The interest actually paid (as above) is 25,852
Excess NIL

No tax relief is due as no interest has been paid in 2010/11.

Although Jack has paid two years interest and the loan has lasted for two years he has lost out on £2,148 of tax relief. This is because the interest due is looked at on a cumulative basis but only the interest actually paid in the tax year is brought into account, so interest paid in relation to any part of a future tax year is disallowed. If Jack delays paying Jill until 5 April the amount due on 1 March in each year he will get tax relief on his full £28,000.

This example assumes that interest at the rate ruling at 1 June 2008 is a “reasonable commercial rate of interest” on the loan for the entire two years. There is a further limitation to the reasonable commercial rate if the rate of interest on the loan exceeds that sum. However it is unclear how that test is applied. It is arguable that a reasonable commercial mortgage rate from December 2008 is around 5% only and it may be even lower by 31 May 2010. Accordingly even if Jack’s loan interest were paid in arrears there might still be disallowable interest because of changes in the commercial rate over the term of the loan. This may depend on how the interest rate is originally fixed. If the rate is comparable to a bank or building society mortgage for the same term at the time it is agreed there is a good argument that it is at a commercial rate throughout the term. However banks and building societies do not normally make long-term fixed rate loans, so such a loan might be regarded as a non-commercial loan and the commercial interest rate assumed by reference to a variable rate loan.