CFM44090 - Deemed loan relationships: alternative finance: deposit arrangements

Deposit arrangements: conditions

A deposit arrangement is equivalent to a conventional bank deposit account. Unlike a purchase and resale arrangement where the financial institution can be either party to the arrangement, under a deposit arrangement the financial institution is the party paying the alternative finance return to the depositor. However it is always possible that the financial institution is a depositor in a deposit arrangement with another financial institution.

CTA09/S505 describes the conditions to be satisfied by a deposit arrangement to be within the loan relationships legislation.

  • A person (‘the depositor’) deposits money with a ‘financial institution’ (CFM44030).
  • The deposit together with money deposited with the financial institution by others is used by the financial institution with a view to producing a profit. For example the financial institution may use the deposits in its own business or invest in third party businesses.
  • From time to time the financial institution pays or credits a payment to the depositor in proportion to the amount deposited by him, out of any profit from the use of the money. The amount paid or credited in a period need not necessarily be the amount of profit earned in that period. The financial institution may calculate the alternative finance return to be paid based on the profit earned in a number of previous periods.
  • The payments or credits made by the financial institution to the depositor are equivalent in substance to a return made on an investment of money at interest.

Under CTA09/S513 the amounts paid or credited to the depositor under the arrangements are taxed as alternative finance return.

Example of a deposit arrangement

Bank M decides to offer a deposit account that instead of paying interest pays a return based on the profit generated from the use of customer deposits into the deposit account. The customer deposits are to be invested in ‘green’ companies and there are penalties for withdrawing the deposits within the first year. The bank aims to pay a return equivalent to an interest rate of 4% per annum payable twice yearly. The bank uses the percentage figure in its publicity but makes it clear that the return will be based on the profits generated.

In the first year the alternative finance return generated by the bank managing the investment in green companies is equivalent to an interest rate of 7%, from which the bank is able to pay the expected return to the customers (i.e. the equivalent of an interest rate of 4%). The bank is not as successful in managing the investments in the second year and is only able to generate a return equivalent to interest at 3%. Nevertheless because of the relatively high return in the previous year the bank is still able to pay its customers a return equivalent to 4% interest for the second year.