CFM39580 - Loan relationships: tax avoidance: regime anti-avoidance rule: examples

CTA09/S455B-D and S698B-D

In considering whether and how the regime anti-avoidance rules might apply to a particular set of facts, it is necessary to answer a number of questions, including:

  • Are there ‘arrangements’ and what is their scope?
  • Does a loan-related or derivative-related tax advantage arise as a result of the arrangements?
  • Was obtaining the tax advantage a main purpose of the arrangements?

Does the tax advantage arise as a result of a provision in Part 5 or Part 7 that was intended to apply in the way which the arrangements envisage?

These questions can only be determined by considering the specific facts of a case, established by careful examination of the evidence available. They cannot necessarily be answered mechanically by reference to generic indicators. Sometimes the facts will be straightforward, and there will be little or no doubt about the application or otherwise of the rules. This will be the case for the great majority of commercial transactions.  

Because these are questions of fact, there will be cases, relatively few in number, that may give rise to material uncertainty. In recognition of this, a number of scenarios are considered below. These are intended to give illustrative guidance on the kind of situations in which the regime anti-avoidance rules may, or may not, apply – always subject to the particular facts and context. The examples are not to be taken as indicating HMRC’s blanket acceptance or approval (or otherwise) of all transactions or arrangements of a similar type, or as in any way limiting HMRC’s ability to counteract using other legislation, where appropriate. In particular, it would be necessary to take account whether there are other factors in play.

 

Cases where the regime anti-avoidance rules are likely to apply

Example 1 – Reflecting economic reality

Arrangements may be aimed at eliminating or reducing credits brought into account by a lender company in respect of economic benefits receivable as (or in lieu of) interest; assuming the evidence shows this to have been a main purpose of the arrangements, they are likely to amount to relevant avoidance arrangements. The discrepancy between amounts brought in to account under Part 5 and the economic reality would be an outcome within S455D(1)(a), so prima facie the exclusion in S455C(4) will not apply.

In such a case, the appropriate counteraction is likely to be the reinstatement of the full amounts of the credits that would have been brought into account by the lender in the absence of the arrangements.

As regards the borrower, provided that debits brought into account properly reflect the amounts and timing of the interest payable under the loan, and the company bears the economic cost of the interest, no counteraction under the regime anti-avoidance rule will be appropriate. However, if the borrower entered into the loan for a non-commercial purpose (including the facilitation of tax avoidance by the lender), the unallowable purpose rule in S441 may operate to disallow some or all of the debits.

 

Example 2 – Taxing all the profits

A company holding a loan that is “in the money” may seek to realise the gain. To avoid being taxed it may transfer the loan to a special purpose vehicle in exchange for the issue of shares for the value of the loan. It may claim that no profit is therefore recognised on the disposal, even though it receives valuable consideration. S306A makes clear that the loan relationships regime is intended to tax all profits from loan relationships (except where special provision is made). Through this arrangement the company has sought to frustrate that principle. There is no Part 5 provision that is intended to permit the tax advantage which would arise in this case, so the S455C(4) exclusion would not be in point, and S455B is likely to apply.

 

Example 3 – Artificial amendment of amounts in accounts  

Arrangements may have the effect of artificially changing the nature of an amount in accounts so that it either is, or is not, recognised as an item of ‘profit or loss’, as opposed to an item of ‘other comprehensive income’, for example. If the arrangements have a main purpose of increasing or decreasing amounts recognised as items of profit or loss so that the Part 5 or Part 7 credits or debits derived from them are affected, then the regime anti-avoidance rules are likely to apply. S455D(1)(c) indicates that the S455C(4) exclusion is unlikely to apply.

 

Example 4 – Group continuity

A company within a group may hold a creditor loan relationship which is standing at a profit and may transfer the loan to another group company. It may argue that, because of the particular arrangements in place, the group continuity rules apply asymmetrically, so that a loss but no profit is recognised. The group continuity provisions are intended to provide continuity of treatment where loans are transferred between two group companies without amounts falling out of account or being relieved twice. Through this arrangement the company has sought to frustrate that principle. There is no Part 5 provision which is intended to permit the tax advantage which would arise in this case, so, as indicated by S455D(1)(g), the S455C(4) exclusion would not be in point, and S455B is likely to apply.

 

Example 5 - Connected company debt impairment

A company which has lent money to a subsidiary may anticipate that it will be required to book an impairment loss in a future period (which would be non-deductible under the rule in S354). It therefore artificially makes arrangements intended to break the connection with the subsidiary (in terms of S466); subsequently relief is claimed for the impairment loss. One of the key features of the loan relationships regime is to deny tax relief for impairment losses on connected company debt. Through this arrangement the company has sought to frustrate that principle of the regime. There is no Part 5 provision which is intended to permit the tax advantage which would arise in this case, so, as indicated by S455D(1)(h), the S455C(4) exclusion would not be in point, and S455B is likely to apply.

 

Example 6 - Unpaid interest

The inclusion of timing effects within the scope of loan or derivative-related tax advantages means that the anti-avoidance rules are capable of applying in cases where, for instance, a loan is put in place with the intention of claiming tax relief for interest which will never in fact be paid. This is, of course, dependent on the arrangements having, for the period in question, a main purpose of achieving that outcome. It would not be reasonable to regard the outcome as consistent with the policy objectives of any provision of Part 5, and the disconnect between the tax loss claimed for the unpaid interest and the economic reality falls within the scope of S455D(1)(b). S455C(4) is therefore unlikely to apply.

 

Example 7 – Miscellaneous

Companies may enter into arrangements aimed at circumventing other elements of the loan relationships or derivative contracts regimes. In such cases, the arrangements are unlikely to be consistent with the aims of those provisions. The S455C(4) exclusion is therefore unlikely to be in point and, assuming there is a main purpose, S455B is likely to apply. Examples might include:

  • The deemed release rules in S361 or S362. Arrangements may seek to avoid an amount being treated as a deemed release, or to reduce the amount. (It should be noted that S363A may apply in priority to S455B in respect of such an arrangement.)

  • Forex hedging structured as a ‘one-way bet’, so that losses would be brought into account while gains would not. This would not apply in cases where exchange gains and losses are disregarded for tax purposes, in accordance with the disregard regulations, for example.

  • Transfer of a loan relationship or derivative contract in a way that results in the full value not being recognised for tax purposes. (The application of the transfer pricing rules may also need to be considered in respect of such an arrangement.)

 
Cases where the regime anti-avoidance rules are unlikely to apply
Example 8 – Accessing non-trade loan relationship deficits brought forward.

A holding company may incur non-trade loan relationship deficits year by year on external borrowing where the funds are passed on to a profit-making trading company as equity (or where the funds are used to acquire equity in such a company). If excess deficits are carried forward in the holding company from before 1 April 2017, the group relief rules prohibit their surrender for set-off against the trading company’s profits in a later year.

The group may make structural changes to avoid this outcome. For example, the holding company may lend money to company B under a new loan relationship. B has a commercial need for the finance, but absent the tax benefits, the loan would not have been made by the holding company, but by another group company (A).  

As a result, instead of A receiving interest from B, the holding company would then receive interest from B. The Part 5 debits on the external borrowing would be unaffected, so no loan-related tax advantage would arise in respect of that for the purposes of s455B.

Arguably in this case, a loan-related tax advantage arises to B in respect of the debits arising from the interest payable. The fact that there is a commercial purpose for the loan does not necessarily preclude a main purpose of obtaining a tax advantage. Whether such a main purpose exists can only be determined by reference to the detailed facts and evidence available.

However, even if the evidence indicates that obtaining the tax advantage was a main purpose of the arrangements, S455C(4) is likely to exclude them from being relevant avoidance arrangements. Assuming the interest is in fact paid, there is a genuine economic loss to B, and interest is within the ‘matters’ dealt with by Part 5. The loan-related tax advantage can therefore reasonably be regarded as consistent with the principles and policy objectives underlying CTA09/S306A. As a result, it would be unlikely that s455B would apply in these circumstances.

Note that if B were not borrowing wholly for commercial purposes, it would be necessary to consider the application of the ‘unallowable purpose’ rule at CTA09/S441. In addition, the loss refresh provision at CTA10/S730G would need to be considered if the tax benefits exceed the non-tax benefits from the arrangements.

 

Example 9 – Regulatory capital

A bank or insurer may become party to, or vary, an instrument designed to ensure that it falls within the Taxation of Regulatory Capital Securities Regulations (S.I. 2013/3209), and therefore that the coupons fall to be deductible under the loan relationship rules. In this case, the regime anti-avoidance rule is unlikely to be applied. The Taxation of Regulatory Capital Securities Regulations contain, in regulation 8, a specific, and broadly drawn, anti-avoidance rule, which should be applied in priority to the regime anti-avoidance rule. If regulation 8 is not invoked, S455B is unlikely to apply.

The Taxation of Regulatory Capital Security Regulations have now been repealed with effect from 1 January 2019 (subject to certain transitional provisions).

 

Example 10 – Thin capitalisation

It is not intended that the S455B rule should be used in straightforward cases where arrangements are undertaken which involve a UK company simply borrowing funds under a loan relationship and seeking relief for the ordinary interest payable. 

Where a company borrows for commercial purposes and incurs a commercial cost for that borrowing, the loan relationships regime will typically permit tax relief for that cost of borrowing in line with the accounts. Although the increased debits sought as a result of the borrowing may amount to a loan-related tax advantage, the arrangements are likely to be excluded from amounting to relevant avoidance arrangements under S455C(4), since the provisions of Part 5 are intended, in general, to allow for the deduction of interest.

Where the borrowing appears that it might be tax driven or the company incurs costs that are not commercial, then the ‘unallowable purpose’ rule at CTA09/S441 should be considered.

Likewise, where there is a concern that the company has borrowed an excessive amount or at an excessive interest rate, then the ‘transfer pricing’ rules in Part 4 of TIOPA should be considered.