A loan note is a kind of IOU from one party to another. Unlike an IOU, a loan note is also a legal contract specifying the duration of the loan, and any agreed interest.
In practical terms they are a useful method of raising funds for commercial purposes, often in property investments or by companies seeking to raise capital.
Loan notes come in different forms. Some are:
- Able to be traded on the stock market
- Either secured or unsecured
Loan Note Terminology
Issuer – The company who has offered the loan note.
Note Holders or Subscribers – The purchaser of the loan note.
Loan Note Instrument – the document laying out the terms and conditions of the loan note, and signed by the issuer.
Loan Note Certificate – This is the official certificate of ownership, much like a share certificate. It is signed by the issuer and the note holder, and constitutes formal evidence of the debt.
Maturity Date – This is the date when the loan must be fully repaid by the issuer.
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What is a Loan Note Investment?
Investing in loan notes may be a way to lend money to companies in profitable areas who are willing to offer much higher rates of interest than almost anywhere else.
As such, loan notes have been a huge area of growth for property developers and businesses. They have also been increasingly popular for investors seeking opportunities as part of a diversified wealth management plan. This is emphasised more recently as the returns from traditional areas of investment have diminished.
They are particularly popular for property developers as they offer a reliable way of raising finance, while the investor gets a level of security if there is a charge over the asset.
What is the Tax Treatment of Loan Notes?
British tax law treats a loan note as a qualifying corporate bond (QCB) or as a ‘non-qualifying corporate bond’ (non-QCB).
QCBs are exempt from Capital Gains Tax while non QCB’s incur CGT, and losses are allowable.
Are Loan Notes Subject to Capital Gains Tax?
Loan notes can be structured as either a qualifying or a non-qualifying corporate bond. The details of how this is defined is laid out in the Taxation of Chargeable Gains Act 1992, Section 117,
Essentially, it is the characteristics of both the security and the underlying debt which define whether a loan note becomes qualified or not. Where the debt has always represented a ‘normal commercial loan’ in sterling, and cannot be converted or redeemed in another currency it qualifies as a QCB, and will hence be afforded Capital Gains exemption.
Are Loan Notes Regulated?
Loan notes, as an investment vehicle, are not regulated in the UK.
Loan notes are classified as a ‘financial promotion’ as per Section 21 of the Financial Services and Markets Act. This means a company cannot invite or induce anyone to invest in them unless they are classified as ‘authorised persons’, meaning sophisticated investors or high net worth individuals.
In some cases, companies offering loan notes will get what is known as a ‘Section 21 sign-off’, meaning the offering has been approved by an FCA regulated company.
Once companies have undergone ‘Section 21 Sign Off’, they will be able to offer investors a degree of reassurance that the offering has been thoroughly vetted. They will also be able to expand their advertising beyond simply high net worth or sophisticated investors.