In this article, which was originally published in the CAIs Tax point journal, EY Tax expert Ronan Costello considers a recent High Court decision which involved the write-off of debt in a property development company. The case is particularly interesting because it involves a detailed discussion on the treatment of a write down of a debt where the underlying asset has decreased in value.

The focus of this article is the recent High Court decision in Arlum Limited v The Revenue Commissioners [2024] IEHC 402 (“Arlum”). In Arlum, the High Court was asked to consider the decision of the Tax Appeals Commission (“TAC”) in 103TACD2023 (“the TAC Decision”).

Background

This case concerned an Irish registered private company limited by shares, Arlum, which was involved in the purchase and development of lands for residential housing. In December 2006, Arlum received a bridging loan of €9.5 million (“the Loan”) from a bank for the acquisition of a site for development (“the Site”). The Loan was drawn down in January 2007. The Loan was approved for a period of 15 months. Security for the loan involved a legal charge over a number of residential units in the planned development, a floating debenture over Arlum’s assets incorporating a fixed charge over the Site, and insurance as required by the bank.

The intention was to develop the Site for residential purposes, however following the acquisition of the Site, Arlum did not develop the Site and instead held the asset as trading stock. The Loan was serviced and capital repayments totalling €3.5 million were made. In June 2016, with a significant portion of the Loan outstanding, the bank forgave the remaining balance of €6.044 million for a net settlement of €250,000. In its income statement for the year ended 31 October 2016, Arlum recorded gross profit of €15,350. The debt forgiveness was recorded as a credit sum below the gross profit line on the basis the debt write-off did not represent trading profit. Accordingly, the debt write-off was not included in Arlum’s corporation tax return for that year. Trade losses amounting to €7.187 million were carried forward from the prior year.

In May 2021, Revenue issued a Notice of Determination which reduced the losses forward by the amount of the loan forgiven. Therefore, the losses forward were reduced from €7.187 million to €1.144 million.

The matter at issue

The basis for the assessment was that the provisions of section 87(1) Taxes Consolidation Act (“TCA”) 1997 required that the amount forgiven should be treated a trading receipt on the basis that deductions had been allowed on that same debt. An alternative argument was also made suggesting that the amount was taxable because deductions could have been taken (discussed in further detail below).

Arlum appealed to the TAC on the basis that no tax deduction had ever been claimed or could have been claimed. Rather the Loan was advanced as capital with the bank taking security over certain assets of Arlum. The fact that the profit on the development would be a trading profit would not cut across and change the factual position that the Loan itself was capital in nature. In the TAC Decision, at paragraph 51, Arlum noted the “enduring benefit of capital” observed in the UK case Atherton v British Insulated and Helsby Cables Limited [1926] AC 205 (HL). Further, it cited another UK case Beauchamp v FW Woolworth plc [1989] STC 510 (“Beauchamp”) where it was held that foreign exchange losses arising on loan repayments were not tax deductible as the related borrowing was capital in nature.

In Revenue’s view, the debt write-off was taxable as the assets which were financed by the Loan were impaired and a tax deduction was taken on the basis of that impairment. As the purpose of the Loan was to fund Arlum’s trade, Revenue argued that the Loan should be treated as revenue in nature. Revenue sought to distinguish Beauchamp and rely on the Irish case Brosnan v Mutual Enterprises Ltd [1997] 3 IR 257 (“Brosnan”). The decision in Brosnan meant that the basic principle regarding loans was that where such loans were a means of “fluctuating and temporary accommodation” then they should be regarded as revenue transactions and not accretions to capital.

In summary, Arlum’s position was that deciding the nature of the Loan was a question of fact and that the purpose of the Loan was the relevant fact. Revenue’s position was that the Loan was revenue in nature and should have been booked as income when the bank released the debt in light of the particular facts of the case and having regarding to prior accounting treatment of loans provided to Arlum previously.

The TAC Decision

The TAC found that section 87 TCA 1997 provided for the taxation of debt write-offs where deductions had been allowed as a receipt of the trade and that the tax arose in the period that debt was forgiven. The TAC noted the use of the word “shall” in section 87(1) TCA 1997 stating it indicated “an absence of discretion in the application of this provision”. The basis for this was that when taken together with section 76A(1) TCA 1997, an alternative method of computation required by law must be applied.

The High Court Decision

The High Court overturned the decision of the TAC on the basis that its interpretation of section 87(1) TCA 1997 was incorrect and an error of law. In its view, the “writing down of the value of the [Site] and carrying forward losses as a result” did not equate to a deduction for the related debt.

The Court considered the TAC’s finding that the write down in the value of the property was considered a deduction for the debt for the purposes of section 87(1) TCA 1997. In the Court’s view, this was not a finding of fact but a question of law. It then followed from this that the burden of proof did not fall on Arlum as the taxpayer, citing Hanrahan v The Revenue Commissioners [2024] IECA 113.

At this point, it is worth noting the alternative argument made by Revenue at the TAC that section 76A(1) TCA 1997 brought the release of the debt within the charge to tax regardless of whether deductions had been claimed or security impaired. This was not in the Case Stated and so it was questionable whether the Court had jurisdiction to consider the argument. In considering Westlink Toll Bridge Limited v Commissioner of Valuation [2013] IESC 42, the Court was satisfied that as the Case Stated did not include a question under section 76A(1) TCA 1997, then the question falls outside the provisions of section 949AR TCA 1997.

Notwithstanding this jurisdictional issue, for completeness the Court did make some comments on Revenue’s arguments under this section. In the Court’s view, section 76A(1) TCA 1997 was not a charging provision. It simply stated that profits of a trade were to be computed in accordance with generally accepted accounting practice (subject to adjustments allowed or required by statute). Further, Arlum’s gross profit for 2016 did not include the value of the release of the debt and the accounts were prepared in accordance with FRS 102, a generally accepted accounting practice. The inclusion of the write-off ‘below the gross profit line’ was done on the basis that the write-off did not represent a trading profit. Lastly, the argument advanced by Revenue in seeking to apply section 76A(1) TCA 1997 to find a basis to tax the write-off would render section 87(1) TCA 1997 redundant. To get around this, it would require inverting the words of section 87(1) TCA 1997 such that the write-off would be chargeable and when that occurs the company could then claim a deduction for the related loan. In the Court’s view, this was plainly not what the provision sought to do.

So, the key question for the Court was whether the TAC had erred in law in applying section 87(1) TCA 1997. In the Court’s view, there was no basis for “reading into the plain words of the section the interpretation contended for”. A plain ordinary meaning of the section did not suggest that the words “debt” or “deduction being allowed” equated to lands or assets or a write-off allowed for lands or assets which drop in value. In this case, Arlum did not claim a deduction for the debt and was not allowed a deduction for the debt in any case. The Site acquired and the Loan which financed the acquisition are not legally the same thing as the debt due by Arlum to the bank. In this case, Arlum was able to reduce the loan by payments from the sale of other properties that had not been purchased with the Loan.

In summary, the Court held that there was no proper basis for inverting the meaning of section 87(1) TCA 1997 or interpreting the word “debt” to mean “an asset purchased using a debt”.

The discussion on statutory interpretation

The leading Irish cases in the area of statutory interpretation are Dunnes Stores v Revenue Commissioners [2020] 3 IR 480 and Bookfinders Ltd v The Revenue Commissioners [2020] IECS 60. The leading Irish cases in the application of these principles are Perrigo Pharma v The Revenue Commissioners [202] IEHC 552 and Heather Hill v An Bord Pleanála [2022] IESC 43 (“Heather Hill”).

In Heather Hill, the High Court set out four basic propositions when interpreting statute. There is the legislative intent deriving from parliament; the actual legal effect of legislation; the words of the statute themselves; and the historic legislative context. The words of the statute themselves are the most important thing to consider.

In Arlum the High Court noted that Revenue’s interpretation conflicted “with the ordinary plain meaning of the words used”. This would lead to problems when applying such an interpretation to subsequent scenarios. The Court also went on to discuss how Revenue’s arguments in relation to section 76A(1) TCA 1997 would lead to “a plainly incorrect interpretation of section 87(1)”.

Closing comments

Arlum makes clear that the starting point for any interpretation of legislation is the plain meaning of the words used. That applies to Revenue, taxpayers and tax advisers.

The case involved a particular issue around section 87 TCA 1997 but it has larger implications for statutory interpretation, tax treatment of loans and debts and the importance of the accounting treatment of an item.

Article authored by Ronan Costello, FS Tax Director, +353 1 221 2129 and Ronan.Costello1@ie.ey.com