CFM42120 - Deemed loan relationships: disguised interest: returns brought into account for other tax purposes

CTA09/S486

Returns brought into account for other tax purposes

Without any rule to the contrary, it would be possible for the disguised interest rules to result in double taxation. This could occur where a return economically equivalent to interest is obtained from an arrangement and the return is already brought into charge for tax purposes.

In order to remove the possibility for double taxation, CTA09/S486C(1) provides that Chapter 2A does not apply if and to the extent that the return is taxed as income or brought into account as income for tax purposes apart from the Chapter.

For instance, the return on a loan relationship or the return that a financial trader earns from acquiring fixed future cash flows or the interest-like return that a financial trader obtains from a combination of financial instruments that together function as a loan. In each of these cases all the return is taxed as income apart from Chapter 2A so Chapter 2A is disapplied.

By contrast the exclusion does not apply where the return comprises a combination of a loss and a profit on two separate items where one is taxed/relieved as income and the other is a tax nothing or a capital matter. In any such case, no part of the return would be brought into account as income apart from Chapter 2A.

Example

Hedge Ltd acquires shares against a long total return swap. Apart from Chapter 2A Hedge Ltd would be taxed on an income basis in respect of the total return swap but would not be charged on an income basis in respect of the shares. However, the combination of the shares and swap will produce disguised interest.

Section 486C(1)(a) to (c) do not apply because if the value of the shares drops, the profit on the swap that would be taxed or brought into account as income is not (to any extent) the return. If the value of the shares increases, the loss on the swap that would be taxed or brought into account as income is similarly not (to any extent) the return. It follows that Chapter 2A can apply (subject to the unallowable test).

In these circumstances, if Chapter 2A does apply, then section 486B(7) (see CFM42090) will prevent any further charge from arising. For instance, in a case where the return includes a loss on a derivative, then under section 486B(7) that loss will not be eligible to relief under the derivate contract rules since it is taken into account in calculating the return.