When lending money to a trading business, whether an unincorporated sole trader, partnership, or limited company

March 12, 2025September 5, 2025Capital Gains TaxMerranti

Claiming Capital Gains Tax (CGT) Relief on Irrecoverable Loans: What You Need to Know

When lending money to a trading business, whether an unincorporated sole trader, partnership, or limited company, there is always an element of financial risk. If the borrower becomes unable to repay the loan, Capital Gains Tax (CGT) relief for irrecoverable loans under TCGA 1992, s 253 may apply, allowing the lender to claim a capital loss against their taxable gains.

However, HMRC has strict criteria for determining when a loan is considered irrecoverable, and understanding these rules is essential to ensure a successful claim. This article explores eligibility, common HMRC challenges, and best practices when applying for CGT loss relief on loans to traders.

What is CGT Loss Relief for Loans to Traders?

Under TCGA 1992, s 253, an individual who has lent money to a trader for business purposes may claim a capital loss if the debt becomes wholly irrecoverable.

Who Qualifies for the Relief?

The loan must be made to a trader, which includes:
- Sole traders
- Partnerships
- Limited companies
The borrower must be trading or preparing to trade.

What Loans Qualify?

The loan must be made for the purpose of the trade.
It must have been genuinely recoverable when made (i.e., the trader was solvent at the time).
The loan must be fully irrecoverable—HMRC does not allow partial claims except in certain cases.

HMRC Guidance on Irrecoverable Loans:

When is a Loan Considered Irrecoverable?

One of the most significant challenges in claiming relief is proving that a loan has become irrecoverable. HMRC applies strict tests and often resists claims if:

The loan was already irrecoverable when made.
The borrower is still trading, as HMRC argues there may still be some chance of recovery.
The loan was partially repaid, meaning it is not wholly irrecoverable.
The lender failed to take reasonable action to recover the loan.

Important: If a trader continues to operate, HMRC may argue that there is still a chance of repayment, making it harder to claim the loan as irrecoverable.

Challenges When Claiming CGT Relief on Irrecoverable Loans

1. The Loan Must Have Been Recoverable When Made

HMRC will reject claims if they determine that the loan was never likely to be repaid. The lender must prove:
The borrower was financially stable when the loan was made.
There was a reasonable expectation of repayment.

Example:

Valid Claim: A business had strong financials when it borrowed money but later collapsed due to unforeseen market conditions.
Invalid Claim: The borrower was already in financial difficulty, and the lender knew the repayment was unlikely.

2. The Trader is Still Operating

If the borrower continues to trade, HMRC may argue that there is still a chance of repayment. However, exceptions exist if:
The business is in severe financial distress.
The lender has exhausted all recovery options (e.g., legal action, debt restructuring attempts).

Tip: If the business has stopped paying other creditors, this may serve as evidence of irrecoverability.

3. No Partial Claims Allowed (Except in Limited Cases)

HMRC insists that the entire loan must be irrecoverable. However, a partial claim may be accepted in two situations:
A company enters liquidation or bankruptcy, and creditors are informed of an expected shortfall.
The loan was partially used for business purposes, and the non-trade portion is excluded from the claim.

Example:
If a director lends £50,000 to their company and it goes into liquidation, they may claim the entire £50,000 as a capital loss. However, if part of the loan was used for non-trade expenses, only the business-related portion qualifies.

4. Multiple Loans to the Same Trader

When a lender provides multiple loans over time, HMRC may challenge claims on the basis that earlier loans were not truly irrecoverable.

Example:
A director provides the following loans to their company:

£20,000 in Year 1
£30,000 in Year 2
£50,000 in Year 3

If they claim a loss on the Year 1 loan, HMRC may argue that because they continued lending in Years 2 and 3, they must have expected some recovery from the earlier loan.

Strategy: Use the first-in, first-out (FIFO) principle, as established in Clayton’s Case (Devaynes v Noble [1816]), to justify claims.

How to Strengthen a CGT Loss Claim on Irrecoverable Loans

To increase the chances of success, the lender should:

Document the Loan Agreement – Clearly state terms, repayment schedule, and interest rate.
Keep Financial Records – Show that the borrower was financially viable when the loan was made.
Attempt to Recover the Debt – Send demand letters, pursue legal action if necessary.
Obtain Evidence of Financial Distress – If the borrower is struggling, secure written confirmation from accountants or insolvency practitioners.
Ensure Loans Are Separate Transactions – If multiple loans were made, treat them as individual advances, rather than a single loan.

Example:
A lender provides three loans:

Loan A – £10,000 (repaid)
Loan B – £20,000 (partially repaid)
Loan C – £50,000 (never repaid)

The lender cannot claim a loss on Loan B, but they can claim for Loan C if it meets HMRC’s irrecoverability test.

Final Thoughts: Is CGT Loss Relief Right for You?

Claiming capital gains tax loss relief on irrecoverable loans can be valuable, but HMRC applies strict criteria. Before making a claim, ensure that:

The loan was made to a genuine trader.
It was recoverable at the time but has since become wholly irrecoverable.
You have sufficient evidence to prove no repayment is possible.
You have attempted to recover the debt.

If your claim meets HMRC’s requirements, you may be able to offset the loss against current or future capital gains, reducing your overall CGT liability.

Need expert tax advice? Merranti Accounting can help assess your eligibility for CGT relief on bad debts, ensuring you remain compliant with HMRC rules.

Contact us today for a free consultation on tax relief strategies.