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Capital Gains Tax (CGT) Loss Relief On Convertible Loan Notes
If your convertible loan note is capable of being characterised as ‘marketable’ and capable of commanding a ‘market price’ over and above the mere value of the loan, it may be possible to claim the debt as a loss for capital gains tax purposes.
Simple debt is not an allowable Loss for Capital Gains Tax Purposes
A loss made on a simple (usually undocumented) loan is not allowable as a gain or loss for capital gains tax purposes (see section 541 (1) (a) of the Taxes Consolidation Act 1997). This is because a simple loan is not considered as capable of appreciating in value for capital gains tax purposes.
However, if the loan is characterised as a ‘debt on a security’ an allowable loss for capital gains tax purposes will be created (see section 541 (1) (b) of the Taxes Consolidation Act 1997). The reason for the foregoing is because a ‘debt on a security’ is considered as a marketable asset, capable of appreciating in value.
What is a ‘debt on a security’?
Section 541 (1)(b) does not define ‘debt’ (and so it has its ordinary meaning) but defines ‘security’ as per section 585 of the TCA ’97 which includes loan stock.
Revenue have clarified in Guidelines on section 541 (par.13.3.) that the reference to loan stock should be regarded as meaning a general class of debt transferable by purchase and sale. The emphasis on ‘transferable’ is in line with the concept of a marketable capital asset capable of appreciating in value. As you will see below, this is the characteristic necessary to classify a convertible loan note as a ‘debt on a security’ pursuant to section 541 (1)(b) of the TCA ’97.
Is a convertible loan note automatically characterised as a ‘debt on a security’?
A convertible loan note is not automatically characterised as a ‘debt on a security’ for the purposes of section 541 (1)(b) of the Taxes Consolidation Act. They key test to apply is whether the loan note possessed the necessary characteristic of ‘marketability’ which would render the holder capable of selling same on the open market (see judgment delivered by Judge Francis Murphy in the Supreme Court case Inspector of Taxes v Keleghan  IESC 43) and receiving an amount over and above the mere value of the loan (also known as making a ‘capital gain’ on a disposal of the asset) (see High Court judgment of Morris J in Mooney v McSweeney 1997 1 ILRM 42).
In the Irish High Court case of Mooney v McSweeney 1997 1 ILRM 429 the claimant was entitled to claim loss relief in respect of the convertible loan advanced in 1985 of £140,000. However in the Supreme Court case of Inspector of Taxes Taxes v Keleghan  IESC 43, the claimant was not permitted to claim loss relief in respect of a convertible loan note which bore different characteristics to that in the first case mentioned – specifically there were restrictions on the right of conversion and no evidence was adduced to suggest that the holder could command a higher value than the funds deemed advanced originally.
It is common for shareholders of privately held companies, and their friends and family members to provide working capital finance to their company by way of a loan. In most cases the loan is provided on an informal basis with little or no supporting documentation. Where the debt cannot be repaid, the shareholder, friend or family member cannot claim capital gains tax loss relief.
Arising from the above we would advise that specific legal advice and assistance would be received before advancing funds to a company.
For further information and advice in relation to “Capital Gains Tax Loss Relief On Convertible Loan Notes”, please contact Deirdre Farrell, partner, Amorys Solicitors firstname.lastname@example.org, telephone 01 213 5940 or your usual contact at Amorys.