CFM51095 - Derivative Contracts: Non-UK resident companies starting to carry on a UK property business
CTA09/S607ZA
Relief for pre-commencement financing costs
From 6 April 2020, a non-resident company which carries on a UK property business, or which has other UK property income, is brought into the scope of UK Corporation Tax. Prior to that date the profits would have been subject to Income Tax.
A non-UK resident company, if it is not carrying on a trade in the UK through a UK permanent establishment or carrying on a trade of developing or dealing in UK land will not have an accounting period until it starts to carry on a UK property business (see PIM2505 for guidance on when a company starts to carry on a UK property business).
S607ZA was therefore introduced in FA20 to allow such companies relief for financing costs incurred prior to the commencement of the property business that would not otherwise be relievable under the derivative contract provisions or the general rule for expenses incurred before the commencement of a trade (CTA09/S61).
Conditions
Relief under S607ZA is available where:
a) a non-UK resident company has debits in respect of a derivative contract held for the purposes of its UK property business,
b) the debits relate to times before (but not more than seven years before) the date on which it starts to carry on the property business, and
c) the debits are not otherwise brought into account for tax purposes.
Effect
The non-resident company will be able to obtain relief for its pre-commencement net financing costs at the point at which it starts to carry on a UK property business.
The amount to be brought into account is limited to the derivative contract debits which:
- would have been recognised in the income statement (as items of profit or loss), and
- would have been brought into account under the derivative contract rules.
In determining the amount to be brought into account the legislation assumes that, at the time the expense was incurred, the company had been carrying on the UK property business (and so, on that basis, would have had an accounting period for Corporation Tax purposes). In addition, where the expense was incurred by the non-resident company before 6 April 2020, HMRC takes it to mean that this assumed UK property business would also be treated as being within the scope of Corporation Tax at that time.
Relief for any such derivative contract debits will be net of any equivalent credits that arise in the same pre-commencement period. No relief is available for derivative contract debits that have been relieved for UK tax purposes under any provision (whether under Corporation Tax or Income Tax).
Capitalised amounts in respect of derivative contracts
In cases where amounts in respect of derivative contracts are capitalised in a company’s financial statements and therefore do not immediately give rise to amounts recognised as items of profit or loss in a company’s income statement, CTA09/S604 may in certain circumstances apply (see CFM52040). Where CTA09/S604 does apply, the amounts capitalised are treated in the same way as an amount that was brought into account as an amount in determining the company’s profit or loss for that period in accordance with GAAP.
S607ZA(2) requires that the company would, on the assumption that it had been carrying on a UK property business at the time, have recognised amounts in profit or loss. As a result, if CTA09/S604 would have applied to the capitalised amounts (i.e. on the assumption that the company had been carrying on a UK property business) then it would follow that these amounts will satisfy the test in S607ZA(2).
Where an election has been made into the Disregard Regulations
The company might choose to make an election into the Disregard Regulations (SI 2004/3256) once it starts to carry on a UK property business and falls within the scope of UK Corporation Tax. Further information on these regulations can be found at CFM57010 on.
Where an election has effect, fair value movements that arise on certain derivative contracts with a hedging relationship (such as interest rate swaps hedging floating rate debt) are disregarded.
When applying S607ZA to determine the amount of debits in earlier periods that would have been brought into account under the derivative contract rules, it is appropriate to calculate these amounts on the assumption that the Disregard Regulations also applied to those periods. This means that any fair value debits referable to times before the UK property business commenced will not be treated as if they were debits of the accounting period in which the UK property business commenced. Instead, the debits should be calculated on an appropriate accruals basis.
Example
A non-resident company, with a calendar year end, takes out floating rate debt of £100m on 1 January 2021 and enters into an interest rate swap to hedge interest rate movements. The borrowing funds the acquisition and development of an office building. Development is completed on 31 December 2023. During this three-year period, cumulative net periodic payments of £1.5m (debit) and net fair value movements of £3.5m (credit) arise on the swap.
The building is let out from 1 January 2024. A UK property business commences on this date and the company elects into the Disregard Regulations for that period, with the result that fair value movements on the interest rate swap are disregarded. S607ZA will bring the net interest debits of £1.5m into account as if they are debits of the accounting period commencing 1 January 2023. The net credits of £3.5m on the fair value movements are not taken into account as “relevant credits” for the purpose of S607ZA because of the assumed application of the Disregard Regulations to those earlier periods.
Under this approach, the company brings into account the net periodic payments under the swap through S607A and the normal operation of the derivative contract rules.
Loan Relationships
A similar provision for debits in respect of loan relationships is made. See CFM32110 for further details.