In Sarah Thomas v HMRC [2026] TC09861, the First Tier Tribunal (FTT) found that a debt assignment from a company to a shareholder was taxable as an income distribution to the extent that it exceeded the shareholder's loan account. A lack of documentary evidence for the loan account and an obstructive approach did not help the taxpayer.
On 19 March 2007, the taxpayer, Sarah Thomas, made a loan of £1 million to Thomas MacLennan Limited (TML), a company in which she was a majority shareholder.
- The taxpayer declared £150,000 of interest in each of her 2007-08 and 2008-09 tax returns, indicating that interest was payable at 15% per annum on a simple, non-compounding basis.
- The loan ran from 19 March 2007 to 1 February 2010, but no interest income for the loan was declared on the taxpayer's 2006-07 or 2009-10 tax returns.
- The interest was payable, but not paid.
- The taxpayer's husband controlled the taxpayer's tax and financial affairs.
- TML's October 2008 accounts showed Shareholders' loan accounts of £1,796,480, but did not break this balance down between shareholders.
Between 2007 and 2010, TML made loans to Nine Regions Limited (NRL), a separately owned company independent of the taxpayer.
- The total amount owed as at 1 February 2010 was £2,135,713.
On 1 February 2010, the NRL loan was assigned by deed to the taxpayer with an accompanying credit against the taxpayer's loan account with TML.
- Later the same day, the taxpayer assigned the benefit of the NRL loan to Spring Capital Limited (SCL) in exchange for a debenture. The taxpayer's husband was a director and 25% shareholder of SCL.
HMRC became aware of the assignment during an enquiry into SCL, and on 13 December 2018, began a compliance check into the taxpayer's tax affairs.
- Due to the taxpayer's lack of cooperation, HMRC issued a Schedule 36 notice. The taxpayer appealed this, but the First Tier Tribunal (FTT) in Sarah Thomas v HMRC [2021] TC08291 dismissed it and confirmed the notice. The taxpayer subsequently provided the requested information and responded to further questions.
On 4 May 2023, HMRC notified the taxpayer that a Discovery assessment for Capital Gains Tax (CGT) would be issued on the basis that the NRL loan was a capital asset for CGT purposes. An assessment was subsequently issued.
- On 31 May 2023, the taxpayer's agents Appealed against the assessment. They argued that the loan did not constitute a debt on security and was therefore not subject to CGT.
- On 26 October 2023, HMRC accepted the CGT point and instead issued an Income Tax assessment. This was on the basis that the debt assignment was an income distribution to the extent that it exceeded the taxpayer's loan account with TML.
- In the assessment, HMRC treated the distribution as other income and applied the higher rate of tax.
- On 26 October 2023, HMRC accepted the CGT point and instead issued an Income Tax assessment. This was on the basis that the debt assignment was an income distribution to the extent that it exceeded the taxpayer's loan account with TML.
- On 14 November 2023, HMRC issued a penalty assessment for deliberate inaccuracy with a 10% reduction. The taxpayer Appealed the assessment.
- On 19 December 2023, HMRC agreed that the distribution should be taxed as dividend income. They provided a revised calculation, which taxed the distribution at the higher dividend rate.
On 22 March 2024, HMRC's internal review upheld their decisions.
- The taxpayer appealed to the FTT on 2 April 2024.
There were several issues to be determined:
- Was the assignment of the debt from TML to the taxpayer taxable as dividend income?
- The taxpayer argued two positions to show that their loan account with TML exceeded the NRL loan amount.
- The first was that if the interest accrued between 2008 and 2010 was added to the shareholders' loan account balance in TML's October 2008 accounts, the loan account balance exceeded the NRL loan balance at the date of transfer.
- The second involved providing a calculation of expenses paid on behalf of TML by the taxpayer's husband. He claimed that he had assigned his right to repayment to the taxpayer.
- The taxpayer argued two positions to show that their loan account with TML exceeded the NRL loan amount.
- Had the assessment been settled by the parties by an agreement under s.54 TMA?
- The taxpayer argued that HMRC's revision of the tax computation in December 2023 amounted to a s.54 agreement cancelling the assessment. This meant that there was no live assessment.
- Had HMRC made a valid Discovery?
- The taxpayer argued that the Income Tax assessment was raised from the same underlying facts as the CGT assessment, so there was no valid discovery under s.29(1) TMA.
- Was the assessment validly issued in time?
- Was there deliberate behaviour permitting a 20-year assessment window under s.36(1a) TMA?
- In assessing the penalty:
- Was the loss of tax brought about deliberately?
- Had HMRC provided appropriate notice of the risk of penalties?
- Had HMRC been overly punitive in discounting the penalty by only 10%?
The FTT found that:
- The taxpayer was liable for Income Tax on a distribution of £655,028, the amount of the NRL assignment that exceeded the taxpayer's loan account.
- The FTT rejected that the shareholders' loan account in TML's 2008 accounts could be treated as Ms Thomas's loan account, since the company's accounts records could not identify to which shareholder the debt was owed.
- Except for employment income due but not paid to the taxpayer, the FTT rejected the calculation of expenses. There was no documentary evidence and the FTT found the taxpayer's husband to be an unreliable witness.
- The FTT produced its own calculations of the taxpayer's loan account, consisting of the verifiable £1 million loan, interest and employment income.
- On this basis, the value of the NRL loan exceeded the taxpayer's loan account.
- The taxpayer and HMRC did not enter into an s.54 agreement.
- This was a procedural argument. The FTT considered that correcting a computational error was not an agreement to discharge or cancel the assessment.
- HMRC's discovery was within s.29, and they were entitled to raise the Income Tax assessment.
- The FTT rejected the taxpayer's claim that the discoveries underpinning the CGT assessment were 'spent' once that assessment had been raised.
- In any case, HMRC's change of mind after being provided with additional information constituted a fresh discovery.
- The 20-year window under s.36(1a) applied, and the assessment was validly issued in time.
- The FTT considered the taxpayer's husband to be a sophisticated businessman with extensive experience in filing tax returns. He had been involved in numerous tax disputes. The failure to declare the income on the return was deliberate.
- There was no reason to interfere with HMRC's penalties.
- As above, the inaccuracy was held to be deliberate.
- HMRC first warned of the possibility of penalties in a letter in September 2022. This had given the taxpayer adequate notice and time to prepare for the penalty assessment issued in May 2023.
- The FTT agreed that the penalty reduction was very low, but considered that no adjustment was needed as the taxpayer had been obstructive and difficult.
- The taxpayer had not declared the interest that would have accrued in 2006-07 or 2009-10. As this did not form part of the appeal, the FTT made no findings on this point.
The appeal was dismissed.
Editor's comment
This case provides a reminder of the importance of documenting and retaining evidence of loan account transactions. It also shows that being combative or uncooperative with HMRC can result in increased penalties.
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