A finance company within the group holds a receivable of $ 207.7 million from an operating company in Kazakhstan. The interest rate is well below the market rate and the operating company is not required to make any payments until 2031. When the company relocates to Hungary in 2018, it claims a loss of $ 37.6 million on that receivable. The court ruled that this loss is not deductible. The receivable should have been recognised on the balance sheet at a lower amount from the outset; had this been the case, there would have been no loss upon the company’s departure.
Worth less than on paper
The value of a claim is not always equal to its nominal value. Suppose someone promises to repay you €100 in fifteen years’ time, without interest. A buyer would pay considerably less for that today, because their money would earn interest elsewhere. That lower price is known as the present value. The operating company pays 0.1 percentage points above the interbank rate, whilst the parties consider a mark-up of 2.75 percentage points to be reasonable. Payment is not due until 1 February 2031. As a result, the present value of the receivable is considerably less than $ 207.7 million.
Payment on departure
The company nevertheless recognises the receivable in full on its balance sheet. For tax purposes, it adds commercial interest to its profit each year. On 25 July 2018, its place of effective management moves to Hungary. In the event of such a departure, the company must be treated as if it were selling its assets at their fair value. For the receivable, this amounts to $ 170.1 million. The company treats the difference from the balance sheet value as a loss. The tax inspector refuses to allow the deduction.
The lower value straight away
According to the court, the company acquired the claim on 9 December 2016 through a transfer within the group. A new asset must be recognised on the balance sheet at its fair value. In this case, that is the present value. The decisive factor is that nothing is due for payment before 2031. Consequently, the amount of interest the company will forgo is already known at the time of acquisition. Each year thereafter, the value increases towards the full amount, and that increase counts as profit.
The error has now been rectified
The receivable has therefore been overstated on the balance sheet since 2016. The inspector is permitted to correct such a balance sheet error in the oldest year for which the accounts are still open. In this case, that is 2018: following the court’s ruling, he has no interest in appealing the decision relating to 2017. On 1 January 2018, the receivable is therefore shown on the balance sheet at a present value of $ 166.5 million. With a value of $ 170.1 million at the time of departure, there is therefore no loss.