CFM37850 - Loan relationships: hybrid capital instruments: tax provisions

Where an instrument meets the CTA09/S475C definition of a hybrid capital instrument, the tax rules make the following provisions.

Equity accounted hybrid capital instruments

CTA09/S320B provides that any amount recognised in equity or shareholders’ funds is brought into account in the same way as if it had been a profit or loss item. It does not apply to amounts that are already recognised as items of profit or loss or as items of other comprehensive income. It also does not apply to amounts of exchange gains or losses recognised in specified statements.

Instruments issued in accounting periods beginning before 1 January 2016 already receive this treatment (see CFM33170). In addition, instruments which fell within the RCS Regulations were also afforded the same tax treatment. The new rules apply this treatment, with effect from 1 January 2019, for equity accounted hybrid capital instruments (HCI) regardless of when issued.

Where exchange gains or losses arise on loan assets or derivative contracts intended to hedge exchange rate risks on an HCI that is equity accounted, those exchange gains or losses are disregarded for tax purposes. This is achieved by amendments to regulations 2, 3 and 4 of the Disregard Regulations 2004 (SI2004/3256).

Normal commercial loans

CTA10/S162(1B) provides that HCI will constitute “normal commercial loans” for the purposes of group relief and the definition of qualifying corporate bonds in relation to capital gains.

Distributions and special securities

Entitlement to defer or cancel interest (CTA09/S420A)

Hybrid capital can only qualify as an HCI where the instrument “makes provision under which the debtor is entitled to defer or cancel a payment of interest” in an accounting period (see CFM37840) (CTA09/S475C(1)(a)).

The ability to defer a payment of interest on a loan relationship will not ordinarily result in any amount being payable being regarded as a distribution (CFM37830).

The ability to cancel a payment of interest on a loan relationship may ordinarily result in any amount payable being regarded as a distribution for the purposes of Part 23 CTA 2010. However, s420A provides that the ability to cancel the interest payable on an HCI does not, by itself, make any amount payable a distribution. S420A(3) ensures that if an instrument qualifies as an HCI any cancellation or deferral of interest (whether mandatory or not) should be disregarded when considering if amounts payable in respect of HCI are distributions.

Example:

An instrument that gives the issuer discretion to cancel interest at any time will qualify as an HCI subject to also meeting the conditions in s475C(1)(b) and (c). If that instrument also has a provision requiring the issuer to cancel payments where the issuer has insufficient distributable reserves, both provisions will come within s420A(3) with the result that both provisions are disregarded in considering if amounts payable in respect of hybrid capital instrument are distributions.

S420A applies for the purposes of the Corporation Tax Acts (section 420A(2)), which, in accordance with Schedule 1 of the Interpretation Act 1978, include enactments relating to the taxation “of company distributions (including provisions relating to income tax)”. It therefore affects the treatment of amounts payable in the hands of both the payer and the recipient.

Equity notes (CTA10/S1015(1A))

A loan relationship which qualifies as an HCI may include provisions that meet the conditions to be an equity note for the purposes of CTA10/S1015(6). Section 1015(1A) provides that an HCI is not a special security by reason of meeting those conditions.

Remaining distribution rules (CTA10/PART23)

However, the remainder of the distribution rules apply to HCI, so that their coupons are only deductible to the extent that they are not distributions. For example, if the instrument carries an excessive rate of interest and is therefore a non-commercial security, as defined by CTA10/S1005, part of the payment may be interest (the reasonable commercial return) with the remainder a distribution.

Corporate Interest Restriction

Under TIOPA10/S413(6) relevant expense amounts arising under an HCI count as adjusted net group-interest expense (ANGIE) for the corporate interest restriction.

Stamp Duties

The transfer of an HCI is exempt from all stamp duties (FA19/Schedule 20/para20).