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CORPORATION TAX – Loan Relationships – FA 1996 unamended – deduction for bad debt?  No because connected parties paragraph 6 Sch 9 FA 1996 applied – appeal dismissed

THE SPECIAL COMMISSIONERS				       

	TREND PROPERTIES LIMITED	Appellant

	- and -

	NICK CRUTCHFIELD 
	(HM INSPECTOR OF TAXES)	Respondents

			Special Commissioner: Adrian Shipwright

					

Sitting in public in London on 21 March 2005

Mr S K Leung, director, for the Appellant

Mrs Jane Hodge, Regional Appeals Unit, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

Introduction
1.	This is an appeal by Trend Properties Limited (“the Company”) against an estimated assessment in the sum of £27,226 and the refusal of a claim to relief dated 16 February 2004.
The Issue
2.	The essential point in this case is whether the Company is entitled to a debit under the loan relationship provisions (as originally enacted) in respect of a loan the Company made to Bestview Investments Limited (“Bestview”) which seemingly has not been recovered.
3.	This raises three matters:
(1)	Were the Company and Bestview connected persons at the relevant time, or within the preceding two years? (“The Connection Point”).
(2)	If so, does Paragraph 6 Schedule 9 Finance Act 1996, in the circumstances under consideration, prevent a deficit arising (even if one would otherwise) by requiring the assumption in section 87 Finance Act 1996, that the debt would be repaid in full in a timely manner to be applied (“the Effect of Paragraph 6”).
(3)	Whether or not there is a non trading deficit to set against the other profits? (“the Deficit Point”).
The Legislation
4.	The relevant legislation is mainly found in Chapter 2 Part 4 and Schedule 9 Finance Act 1996 (“the Provisions”).  It should be noted that this Chapter of the Finance Act 1996 was substantially amended by the Finance Act 2002 for accounting periods beginning after 30 September 2002.  This case is not concerned with the legislation as amended or whether or not it might have lead to a different result had it been in force.
5.	Unsurprisingly, the Provisions are concerned with Loan Relationships as defined in section 81 of the Finance Act 1996.  It is not disputed that there is Loan Relationship here.  Section 80 of the Finance Act 1996 provides that “For the purposes of Corporation Tax, all profits and gains arising to a company from its Loan Relationships shall be chargeable to tax as income” in accordance with the Provisions.
6.	Section 82 of the Finance Act 1996 deals with the method of bringing amounts into account.  Where a company is not carrying on a trade, then the amounts are brought into account as non trading credits and non trading debits, and are chargeable under Schedule D Case III.  Where there is a deficit on a loan relationship, section 83 Finance Act 1996 allows a non trading deficit on loan relationships to be set off against “any profits of the company (of whatever description) for the period in which the deficit arises” (Section 83(2)(a) FA 1996).
7.	The debits and credits to be brought into account are set out in section 84 of the Finance Act 1996.  This provides:
“(1) The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question:
(a)  all profits, gains and losses of the company, including those of a capital nature, which (disregarding interest and any charges or expenses) arise to the company from its loan relationships and related transactions; and
(b)  all interest under the company's loan relationship and all charges and expenses incurred by the company under or for the purposes of its loan relationships and related transactions.
(2) The reference in subsection (1) above to the profits, gains and losses arising to a company:
(a)  does not include a reference to any amounts required to be transferred to the company's share premium account; but
(b) does include a reference to any profits, gains or losses which, in accordance with normal accountancy practice, are carried to or sustained by any other reserve maintained by the company.
(3) The reference in subsection (1)(b) above to charges and expenses incurred for the purposes of a company's loan relationships and related transactions does not include a reference to any charges or expenses other than those incurred directly:
(a)  in bringing any of those relationships into existence;
(b)  in entering into or giving effect to any of those transactions;
(c)  in making payments under any of those relationships or in pursuance of any of those transactions; or
(d)  in taking steps for ensuring the receipt of payments under any of those relationships or in accordance with any of those transactions.
(4) Where:
(a) any charges or expenses are incurred by a company for purposes connected:
(i)  with entering into a loan relationship or related transaction; or
(ii) with giving effect to any obligation that might arise under a loan relationship or related transaction,
(b)  at the time when the charges or expenses are incurred, the relationship or transaction is one into which the company may enter but has not entered, and

(c)  if that relationship or transaction had been entered into by that company, the charges or expenses would be charges or expenses incurred as mentioned in subsection (3) above, those charges or expenses shall be treated for the purposes of this Chapter as charges or expenses in relation to which debits may be brought into account in accordance with subsection (1)(b) above to the same extent as if the relationship or transaction had been entered into.
(5) In this section "related transaction", in relation to a loan relationship, means any disposal or acquisition (in whole or in part) of rights or liabilities under that relationship.
(6) The cases where there shall be taken for the purposes of this section to be a disposal and acquisition of rights or liabilities under a loan relationship shall include those where such rights or liabilities are transferred or extinguished by any sale, gift, exchange, surrender, redemption or release.
(7) This section has effect subject to Schedule 9 to this Act (which contains provision disallowing certain debits and credits for the purposes of this Chapter and making assumptions about how an authorised accounting method is to be applied in certain cases).

8.	Authorised accounting methods are defined in section 85 of the Finance Act 1996.  This provides:
“(1) Subject to the following provisions of this Chapter, the alternative accounting methods that are authorised for the purposes of this Chapter are:
(a)  an accruals basis of accounting; and
(b) a mark to market basis of accounting under which any loan relationship to which that basis is applied is brought into account in each accounting period at a fair value.
(2) An accounting method applied in any case shall be treated as authorised for the purposes of this Chapter only if:
(a)  it conforms (subject to paragraphs (b) and (c) below) to normal accountancy practice, as followed in cases where such practice allows the use of that method;
(b)  it contains proper provision for allocating payments under a loan relationship to accounting periods; and
(c)  where it is an accruals basis of accounting, it does not contain any provision (other than provision comprised in authorised arrangements for bad debt) that gives debits by reference to the valuation at different times of any asset representing a loan relationship.
(3) In the case of an accruals basis of accounting, proper provision for allocating payments under a loan relationship to accounting periods is provision which:
(a)  allocates payments to the period to which they relate, without regard to the periods in which they are made or received or in which they become due and payable;
(b)  includes provision which, where payments relate to two or more periods, apportions them on a just and reasonable basis between the different periods;
(c)  assumes, subject to authorised arrangements for bad debt, that, so far as any company in the position of a creditor is concerned, every amount payable under the relationship will be paid in full as it becomes due;
(d) secures the making of the adjustments required in the case of the relationship by authorised arrangements for bad debt; and
(e)  provides, subject to authorised arrangements for bad debt and for writing off government investments, that, where there is a release of any liability under the relationship, the appropriate amount in respect of the release is credited to the debtor in the accounting period in which the release takes place.
(4) In the case of a mark to market basis of accounting, proper provision for allocating payments under a loan relationship to accounting periods is provision which allocates payments to the accounting period in which they become due and payable.
(5) In this section:
(a)  the references to authorised arrangements for bad debt are references to accounting arrangements under which debits and credits are brought into account in conformity with the provisions of paragraph 5 of Schedule 9 to this Act; and
(b) the reference to authorised arrangements for writing off government investments is a reference to accounting arrangements that give effect to paragraph 7 of that Schedule.
(6) In this section "fair value", in relation to any loan relationship of a company, means the amount which, at the time as at which the value falls to be determined, is the amount that the company would obtain from or, as the case may be, would have to pay to an independent person for:
(a)  the transfer of all the company's rights under the relationship in respect of amounts which at that time are not yet due and payable; and
(b)  the release of all the company's liabilities under the relationship in respect of amounts which at that time are not yet due and payable.”
9.	It should be noted that section 85(3)(c) FA 1996 (see 8 above for text) requires an assumption to be made that the creditor company will be paid in full as obligations fall due.
10.	The application of accounting methods is dealt with in section 86 of the Finance Act 1996.  This provides:
“(1) This section has effect, subject to the following provisions of this Chapter, for the determination of which of the alternative authorised accounting methods that are available by virtue of section 85 above is to be used as respects the loan relationships of a company.
(2) Different methods may be used as respects different relationships or, as respects the same relationship, for different accounting periods or for different parts of the same accounting period.
(3) If a basis of accounting which is or equates with an authorised accounting method is used as respects any loan relationship of a company in a company's statutory accounts, then the method which is to be used for the purposes of this Chapter as respects that relationship for the accounting period, or part of a period, for which that basis is used in those accounts shall be:
(a)  where the basis used in those accounts is an authorised accounting method, that method; and
(b)  where it is not, the authorised accounting method with which it equates.
(4) For any period or part of a period for which the authorised accounting method to be used as respects a loan relationship of a company is not determined under subsection (3) above, an authorised accruals basis of accounting shall be used for the purposes of this Chapter as respects that loan relationship.
(5) For the purposes of this section (but subject to subsection (6) below):
(a)  a basis of accounting equates with an authorised accruals basis of accounting if it purports to allocate payments under a loan relationship to accounting periods according to when they are taken to accrue; and
(b)  a basis of accounting equates with an authorised mark to market basis of accounting if (without equating with an authorised accruals basis of accounting) it purports in respect of a loan relationship:
(i)  to produce credits or debits computed by reference to the determination, as at different times in an accounting period, of a fair value; and
(ii) to produce credits or debits relating to payments under that relationship according to when they become due and payable.
(6) An accounting method which purports to make any such allocation of payments under a loan relationship as is mentioned in subsection (5)(a) above shall be taken for the purposes of this section to equate with an authorised mark to market basis of accounting (rather than with an authorised accruals basis of accounting) if:
(a)  it purports to bring that relationship into account in each accounting period at a value which would be a fair value if the valuation were made on the basis that interest under the relationship were to be disregarded to the extent that it has already accrued; and
(b)  the credits and debits produced in the case of that relationship by that method (when it is properly applied) correspond, for all practical purposes, to the credits and debits produced in the case of that relationship, and for the same accounting period, by an authorised mark to market basis of accounting.
(7) In this section "fair value" has the same meaning as in section 85 above.
(8) In this section "statutory accounts", in relation to a company, means:
(a)  any accounts relating to that company that are drawn up in accordance with any requirements of the Companies Act 1985 or the Companies (Northern Ireland) Order 1986 that apply in relation to that company;
(b)  any accounts relating to that company that are drawn up in accordance with any requirements of regulations under section 70 of the Friendly Societies Act 1992 that apply in relation to that company;
(c)  any accounts relating to that company which are accounts to which Part I of Schedule 21C to the Companies Act 1985 or Part I of Schedule 21D to that Act (companies with UK branches) applies;
(d)  in the case of a company which:
(i)  is not subject to any such requirements as are mentioned in paragraphs (a) or (b) above, and
(ii) is a company in whose case there are no accounts for the period in question that fall within paragraph (c) above, any accounts relating to the company drawn up in accordance with requirements imposed in relation to that company under the law of its home State; and
(e)  in the case of a company which:
(i)  is not subject to any such requirements as are mentioned in paragraphs (a), (b) or (d) above, and
(ii) is a company in whose case there are no accounts for the period in question that fall within paragraph (c) above, the accounts relating to the company that most closely correspond to the accounts which, in the case of a company formed and registered under the Companies Act 1985, are required under that Act.
(9) For the purposes of subsection (8) above the home State of a company is the country or territory under whose law the company is incorporated.”
11.	The Provisions required an accruals accounting method to be used where the parties have a connection.  The authority for this is section 87 of the Finance Act 1996 which provides:
“(1) This section applies in the case of a loan relationship of a company where for any accounting period there is a connection between the company and:
(a)  in the case of a debtor relationship of the company, a person standing in the position of a creditor as respects the debt in question; or
(b)  in the case of a creditor relationship of the company, a person standing in the position of a debtor as respects that debt.
(2) The only accounting method authorised for the purposes of this Chapter for use by the company as respects the loan relationship shall be an authorised accruals basis of accounting.
(3) For the purposes of this section there is a connection between a company and another person for an accounting period if (subject to subsection (4) and section 88 below):
(a)  the other person is a company and there is a time in that period, or in the two years before the beginning of that period, when one of the companies has had control of the other;
(b)  the other person is a company and there is a time in that period, or in those two years, when both the companies have been under the control of the same person; or
(c)  there is a time in that accounting period, or in those two years, when the company was a close company and the other person was a participator in that company or the associate of a person who was such a participator at that time.
(4) Two companies which have at any time been under the control of the same person shall not, by virtue of that fact, be taken for the purposes of this section to be companies between whom there is a connection if the person was the Crown, a Minister of the Crown, a government department, a Northern Ireland department, a foreign sovereign power or an international organisation.
(5) The references in subsection (1) above to a person who stands in the position of a creditor or debtor as respects a loan relationship include references to a person who indirectly stands in that position by reference to a series of loan relationships.
(6) Subsections (2) to (6) of section 416 of the Taxes Act 1988 (meaning of "control") shall apply for the purposes of this section as they apply for the purposes of Part XI of that Act.
(7) Subject to subsection (8) below, in this section "participator" and "associate" have the meanings given for the purposes of Part XI of the Taxes Act 1988 by section 417 of that Act.
(8) A person shall not for the purposes of this section be regarded as a participator in relation to a company by reason only that he is a loan creditor of the company.
There is an exemption from section 87 in section 88 of the Finance Act 1996 which does not apply in the circumstances under consideration.
12.	Section 85 provides an exception from the assumption of timely payment in full where “authorised arrangements for bad debts” apply.  The arrangements for bad debts are dealt with in paragraphs 5 and 6 Schedule 9 of the Finance Act 1996.  These provide:
“5. (1) In determining the credits and debits to be brought into account in accordance with an accruals basis of accounting, a departure from the assumption in the case of the creditor relationships of a company that every amount payable under those relationships will be paid in full as it becomes due shall be allowed (subject to paragraph 6 below) to the extent only that:
(a) a debt is a bad debt;
(b) a doubtful debt is estimated to be bad; or
(c) a liability to pay any amount is released.
(2) Such a departure shall be made only where the accounting arrangements allowing the departure also require appropriate adjustments, in the form of credits, to be made if the whole or any part of an amount taken or estimated to represent an amount of bad debt is paid or otherwise ceases to be an amount in respect of which such a departure is allowed.
(3) Where:
(a) a liability to pay any amount under a debtor relationship of a company is released, and
(b) the release takes place in an accounting period for which an authorised accruals basis of accounting is used as respects that relationship, no credit in respect of the release shall be required to be brought into account in the case of that company if the release is part of a relevant arrangement or compromise (within the meaning given by section 74(2) of the Taxes Act 1988) or the relationship is one as respects which section 87 of this Act requires the use of an authorised accruals basis of accounting
6. (1) This paragraph applies where for any accounting period section 87 of this Act requires an authorised accruals basis of accounting to be used as respects a creditor relationship of a company.
(2) The credits and debits which for that period are to be brought into account for the purposes of this Chapter in accordance with that accounting method shall be computed subject to sub-paragraphs (3) to (6) below.
(3) The assumption that every amount payable under the relationship will be paid in full shall be applied as if no departure from that assumption were authorised by virtue of paragraph 5 above except where it is allowed by sub‑paragraph (4) below.
(4) A departure from that assumption shall be allowed in relation to a liability to pay any amount to the company ("the creditor company") under the creditor relationship where:
(a) in consideration of, or of any entitlement to, any shares forming part of the ordinary share capital of the company on whom the liability would otherwise have fallen, the creditor company treats the liability as discharged; and
(b) the condition specified in sub-paragraph (5) below is satisfied.
(5) That condition is that there would be no connection between the two companies for the accounting period in which that consideration is given if the question whether there is such a connection for that period fell to be determined, in accordance with section 87 of this Act, by reference only to times before the creditor company acquired possession of, or any entitlement to, the shares in question.
(6) Where the company ceases in the accounting period in question to be a party to the relationship:
(a) the debits brought into account for that period in respect of that relationship shall not (subject to sub-paragraph (7) below) be more than they would have been had the company not ceased to be a party to the relationship; and
(b) the credits brought into account for that period in respect of the relationship shall not (subject to that sub-paragraph) be less than they would have been in those circumstances.
(7) In determining for the purposes of sub-paragraph (6) above the debits and credits that would have been brought into account if a company had not ceased to be a party to a loan relationship, no account shall be taken of any amounts that would have accrued at times after it ceased to be a party to the relationship.”
13.	The definition of connection for these purposes is to be found in section 87(3) of the Finance Act 1996 (see above).  Sub-paragraph (b) provides that there is a connection between a company and another company if, at the time in question or in the preceding two years, both the companies have been under the control of the same person.  By subsection (6) section 416(2) to (6) TA apply to determine the meaning of “control” and by subsection (7) section 417 TA applies to determine the meaning of “associate”.
14.	 Section 416(2) to (6) TA provides:
“(2)  For the purposes of this Part, a person shall be taken to have control of a company if he exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs, and in particular, but without prejudice to the generality of the preceding words, if he possesses or is entitled to acquire: 
(a)  the greater part of the share capital or issued share capital of the company or of the voting power in the company; or
(b)  such part of the issued share capital of the company as would, if the whole of the income of the company were in fact distributed among the participators (without regard to any rights which he or any other person has as a loan creditor), entitle him to receive the greater part of the amount so distributed; or
(c)  such rights as would, in the event of the winding-up of the company or in any other circumstances, entitle him to receive the greater part of the assets of the company which would then be available for distribution among the participators.
(3)  Where two or more persons together satisfy any of the conditions of subsection (2) above, they shall be taken to have control of the company.
(4)  For the purposes of subsection (2) above a person shall be treated as entitled to acquire anything which he is entitled to acquire at a future date, or will at a future date be entitled to acquire.
(5)  For the purposes of subsections (2) and (3) above, there shall be attributed to any person any rights or powers of a nominee for him, that is to say, any rights or powers which another person possesses on his behalf or may be required to exercise on his direction or behalf.
(6)  For the purposes of subsections (2) and (3) above, there may also be attributed to any person all the rights and powers of any company of which he has, or he and associates of his have, control or any two or more such companies, or of any associate of his or of any two or more associates of his, including those attributed to a company or associate under subsection (5) above, but not those attributed to an associate under this subsection; and such attributions shall be made under this subsection as will result in the company being treated as under the control of five or fewer participators if it can be so treated.
15.	Section 417 provides (inter alia)
“(3)  For the purposes of this Part "associate" means, in relation to a participator:
(a)  any relative or partner of the participator;
(b) the trustee or trustees of any settlement in relation to which the participator is, or any relative of his (living or dead) is or was, a settlor ("settlement" and "settlor" having here the same meaning as in section 681(4)); and
(c)  where the participator is interested in any shares or obligations of the company which are subject to any trust, or are part of the estate of a deceased person:
(i)  the trustee or trustees of the settlement concerned or, as the case may be, the personal representatives of the deceased; and
(ii)  if the participator is a company, any other company interested in those shares or obligations;
and has a corresponding meaning in relation to a person other than a participator.”
Cases referred to
16.	The parties referred to the following cases:
R v IRC ex p. Newfield Developments Limited [2001] M23 TC 532
Steele v EVC [1996] STC 785
Gascoines Group Ltd [2004] EWHC 640 [2004] STC 844 
Documents
17.	An agreed bundle of documents was produced including a Statement of Facts that were not disputed.  ‘Statement of Facts not disputed’ is not an entirely accurate description as paragraph 6 of that Statement that there was a partnership between Mr Leung and Mr Knight was disputed by the Appellant.  The parties, when asked whether to proceed on the basis that all the facts in the Statement were agreed other than paragraph 6, agreed to proceed on the basis that this was the case, ie that the Statement of Facts other than paragraph 6 was agreed.  I have proceeded on this basis.
Evidence
18.	Oral evidence was given by Mr John Jeremy Knight (for whom a Witness Statement was provided) and by Mr Leung.
Finding of Facts 
19.	From the documents and the evidence, I make the following findings of facts:
Trend Properties Limited (“the Company”)
20.	The Company’s “main activities are that of a commercial landlord” for the period ending 31 December 1997 according to its Accounts for the period.
21.	Mr S K Leung was a director for that period.  The Company’s auditors for that period were the William Philip Partnership.
22.	The ultimate parent company of the Company was Temporal Investment Limited.  The Company’s Accounts record that Temporal Investment Limited is controlled by Mr S K Leung.  He was beneficially entitled to all the issue share capital.
23.	In summary, I find that the Company was not carrying on a trade and was a one hundred per cent subsidiary of Temporal Investment Limited that was wholly owned beneficially by Mr S K Leung.
Bestview Investments Limited (“Bestview”)
24.	Bestview was a company acquired off the shelf.  It was intended that Bestview should carry on business providing Children’s Nurseries but it failed to obtain the necessary permissions and registration.  It did not commence business.  Bestview was struck off on 14 May 2002.
25.	Bestview had an authorised Share Capital of 100 £1 Ordinary Shares.  Two Shares were in issue.  One was owned by Mr S K Leung, the other by Mr J Knight.  Bestview borrowed money from the Company.
The Debt
26.	The Company lent Bestview £23,265 (“the Debt”) in 1997 to start up a day nursery business.  This was an agreed fact between the parties.
27.	The Company’s Accounts for the period ended 31 December 1997 do not refer to the Debt in any way in the Profit and Loss Account.  Those Accounts show in Note 7 to the Balance Sheet Sundry Debtors of £72,108.  It is agreed fact that the Debt forms part of this sum.
28.	The Company’s Accounts for the period do not show the Debt as bad, dubious or irrecoverable, nor is there any Note to the Accounts to that effect.
William Phillip Partnership
29.	Mr Leung and Mr Knight bought the William Philip Partnership (“the Partnership”) in  about 1996. They were partners at the relevant time(s).
30.	Mr Knight was shown on the Partnership’s notepaper as a partner.  Returns were made of partnership profits and gains.  Mr Knight made partnership returns.  Evidence was given that Mr Knight needed to be shown as a partner so that certain types of business could be carried on by the Partnership.
31.	It was suggested that the Partnership was an investment.  It was also suggested that Mr Knight may have assigned some or all of his partnership Share to his daughter.  There was no contemporary evidence to this effect.  A document was produced which had been recently executed which purported to assign the Partnership Share as between the parties from a date that might have been significant.  However, there was no evidence that as against third parties there had been an assignment such that Mr Knight was not a partner at the relevant times.  Even if there were an assignment I find that Mr Knight had been a partner before the assignment.
32.	I find as a primary fact that at the relevant times Mr Knight ad Mr Leung were carrying on business, they were carrying on such business in common and that they were doing so with a view to profit.  I find therefore that Mr Leung and Mr Knight were partners at the relevant time(s). 
Appellant’s contentions
33.	In essence the Appellant contended that:
(1)	there was no partnership; and 
(2)	even if there were, Mr Leung did not have control of both Bestview and the Company.
34.	Mr Leung, in his attractive and forceful submissions expanded on this as follows:
(a)	There was no partnership.  It had not been established that there is anything more than an investment by Mr Knight in the accountancy business.
(b)	Mr Knight was not really a partner as he took no part in the day-to-day business or day-to-day running of William Phillip Partnership.  He was therefore not strictly a partner.  Accordingly, he could not be an associate within the meaning of section 417(3)(a) TA.  As a result, section 416 TA could not apply and both companies were not controlled by the same person.
(c)	There was no control by the same person of Trend and Bestview.
(d)	Section 416(2) TA was, accordingly, not fulfilled.  There is no attribution that can establish control of these two companies.
(e)	Trend Shares cannot be attributed to Mr Knight, and Mr Leung does not have participatory control of Trend.
(f)	Section 416(6) TA which provides:
“There may be attributed to any person all the rights and powers of any company of which he has, or he and associates of his have control…”
does not assist here.  It can only mean the shares of a company controlled by the person or his associate can be attributed.  Mr Knight and Mr Leung do not each control Bestview for the purposes of attribution.  Either is only deemed to take participatory control after this test of attribution.  Since neither control Bestview by virtue of their 50% shareholdings, then the share of Bestview owned by one cannot be attributed to the other under section 416(6) TA. There was a difference between shareholder and director control. One could not attribute so as to say there shareholder control because of the phrasing of section 416 TA.
(g)	Control in the first part of section 416(2) was different in meaning from the second part. One was concerned with shareholder control whilst the other was concerned with director control. This distinction between Shareholder and Director control was important here and limited the ability to attribute Mr Knight’s shares to Mr Leung.
(h)	 Accordingly the Company and Bestview were not connected persons and bad debt relief was available for the period.
The Revenue’s contentions
35.	The Revenue’s contention was that, in essence, Mr Leung had control under section 416 TA of both Bestview and the Company so they were connected such that paragraph 6 Schedule 9 of the Finance Act 1996 denied any bad debt relief in respect of a Loan Relationship between them. Further, there was no Loan Relationship debit under section 84(1)(a) as the accounts did not show one and because of paragraph 6 of the Schedule. There was no debit, therefore there could be no deficit as there was nothing to take into account as a deductible.  Accordingly, the set-off claim was not allowable.
36.	 Mrs Hodge expanded on this as follows:
(a)	In its statutory accounts for the accounting period ended 31 December 1997, Trend had included the amount in its balance sheet under ‘current assets’.  No part of this debt has been written off through the profit and loss account, or any reserve account for that or an earlier period.
(b)	Section 87 applies to a Loan Relationship where there is a connection between the creditor and the debtor. This was the case here as under section 416 TA (as applied by the Provisions) Mr Leung had control of both companies. It is clear that the control test in section 416(2) can apply to people who have no real control over a company’s affairs but who are to be taken to be having control (see Lord Hoffman in IRC ex p. Newfield Developments Limited (above) at paragraph 11).
(c)	The Company was wholly controlled by Templar Investments Limited which was wholly owned by Mr Leung.  Accordingly, Mr Leung controls the Company by virtue of the attribution to him of the rights and powers of Templar Investments Limited under section 416(6) TA.  It does not matter that Mr Leung does not have direct participatory control of the Company.
(d)	Mr Knight and Mr Leung were partners in the Partnership in 1997. There is no requirement that a partner must be active or directly involved in the day-to-day running of the partnership to be a partner within the meaning of section 417(3)TA. Mr Knight was accordingly an associate of Mr Leung during the accounting period ended 31 December 1997.  The power and rights of Mr Knight in Bestview can be attributed to Mr Leung under section 416(6) TA.  The Company and Bestview are therefore connected within the meaning of section 87(3)(b) Finance Act 1996.
(e)	Accordingly, only an accruals method of accounting can be applied.  By section 85, an accruals basis is one which makes proper provision for allocating payments to accounting periods which “assumes, subject to authorised arrangements for bad debt, that, so far as any company in the position of a creditor is concerned, every amount payable under the relationship will be paid in full as it becomes due”.  The assumption full and timely payment by Bestview prevents Trend from obtaining any relief in respect of Bestview’s default.  The only circumstances under which Trend can depart from this assumption are those permitted by authorised arrangements for bad debts in Schedule 9 FA 1996.
(f)	These are to be found in paragraphs 5 and 6 of the Schedule.  Paragraph 5 allows relief for a doubtful debt, a one that is estimated to be bad or released by the creditor.  However, paragraph 6 applies where the parties are connected to stop paragraph 5 allowing relief.  Paragraph 6 (3) overrides paragraph 5 and requires Trend to proceed on the basis of the statutory fiction of full and timely payment set out in section 85(3) (c) Finance Act 1996). 
(g)	Accordingly, even if the debt due from best/Bestview is bad, Trend is required by statute to prepare its tax computations on the basis that it will receive its money in the period in which it is due.  
(h)	Accordingly, Trend is not entitled to relief for any amount in connection with its loan relationship with Bestview. 
Discussion
35.	The contentions of the parties raise a number of issues.  The first is whether or not there was a partnership? If so assuming that there was a deficit then the Connection Point and the Effect of Paragraph 6 arise.  I will deal with each of these in turn.
Was there a Partnership?
36.	In his Witness Statement, Mr John Knight said that he was a practising accountant.  In 1996 he and Mr Leung decided to purchase a firm of Accountants in Colchester jointly.  The original Partnership was ended in 2001 and all engagements were assumed by William Phillip Partnership Limited.  All day-to-day management decisions were made by Mr Leung.  Mr Knight said:
“I treated this participation in the Partnership as an investment.”
37.	Mr Knight seemed to think that he had assigned his interest in the Partnership, but there was no corroborated evidence when this was done or that it was done at a relevant time.  However, the notepaper described the business as a Partnership and Mr Knight as a partner. Tax returns were made on the basis that there was a partnership.
38.	I find as a fact that Mr Knight and Mr Leung were in the relationship of persons carrying on business in common with a view to profit.  They thus satisfied the requirements of section 1 of the Partnership Act 1890 to establish a Partnership. Even if there was assignment in 1997 (which I have found there was not) I find that Mr Knight had been a partner before such an assignment and so within the two years before the end of the relevant accounting period.   
Connection Point
39.	It having been established that Mr Leung and Mr Knight were in partnership, it follows that Mr Knight was an associate of Mr Leung’s.
40.	Mr Leung owned one hundred per cent of Temporal Investments Limited, which owned one hundred per cent of the Company.  Accordingly, for the purposes of section 416, Mr Leung controlled the Company.
41.	Mr Knight and Mr Leung were the joint owners of Bestview.  They owned half of the issued share capital each.
42.	Mr Knight and Mr Leung together had control of Bestview.  This is because by section 416(3) TA Mr Leung and Mr Knight would own the greater part of the share capital of Bestview.  Accordingly, they would satisfy sub-section (2)(a) and so are to be taken to have control of Bestview.
43.	By sub-section (6) of section 416, for the purposes of sub-section (2) there can be attributed to Mr Leung all the rights and powers of any associate of Mr Leung.  On that basis Mr Leung can be treated as having control of Bestview.  It is also the case that Mr Knight could be so treated.  This does not matter as more than one person can be treated as having control under section 416 TA nor does it matter whether Mr Leung or Mr Knight factually exercised control. As Lord Hoffman said in IRC ex p. Newfield Developments Limited (above) at paragraph 11:
“…For the purpose of deciding whether a person ‘shall be taken to have control of the company’ under section 416(2), it may be necessary to attribute to him the rights and powers of persons over whom he may in real life have little or no power of control.  Plainly, the intention of the legislature was to spread the net very wide.”
He continued at paragraph 19:
“Even without subsections (6) [of section 416], the definition of control is wide and can apply to persons who have no control over the company affairs.”
43.	The effect of this is that Mr Leung is treated as having control of the Company and as having control of Bestview.  Accordingly, Trend and Bestview are connected for the purposes of section 87.
44.	They are thus required to use an accruals method in computing Corporation Tax by virtue of the Provisions.
Effect of Paragraph 6
45.	As the Company and Bestview are connected and so required to use an accruals method by section 87 paragraph 6 of Schedule 9 denies bad debt relief under paragraph 5 of the Schedule by requiring the assumption that there will be full and timely payment of the debt to be applied.
46.	Accordingly, for the purpose of the Provisions it has to be assumed that Bestview will make full and timely payment of its obligations.  On that basis no bad debt would arise.  No amount would be deductible in respect of the debt owed by Bestview to the Company.  The effect of this is that no deduction would be allowed and so no deficit would arise in respect of the debt. The effect of paragraph 6 is to deny relief even if there were a bad debt.
Was there a deficit? – The Deficit Point
47.	In the light of the discussion above, this point does not arise for determination.  However, if it did I would be minded to decide the issue in favour of the Respondents.   
Conclusion
48.	 Accordingly, for the reasons given above, I dismiss the appeal and uphold the denial of bad debt relief and reduce the estimated assessment to £25,459.00.   

ADRIAN SHIPWRIGHT
SPECIAL COMMISSIONER
             
                                                Release Date: 24 May 2005

SC/3138/2004