CFM95660 - Interest restriction: tax-interest: implicit financing costs

TIOPA10/S382 and TIOPA10/S385

The tax-interest amount includes amounts in respect of the financing costs implicit in amounts payable under a relevant arrangement or transaction. This includes:

  • A finance lease;
  • Debt factoring or any similar transaction; and
  • A service concession arrangement to the extent it is accounted for as a financial liability.

Example

A company acquires the use of an asset under a five-year finance lease with rental payments of £10,000 per month. The total due under the lease is therefore £600,000 whereas the cost of buying the asset outright would have been £500,000. This £100,000 difference is the implied financing expense over the term of the lease and an expense of £20,000 (£100,000 divided by 5 years) will be included in the tax-interest amount each year to reflect this. The tax-interest amount for both lessor and lessee should therefore include this amount.

Hire Purchase Agreement

Under a hire purchase agreement, a person may pay for an asset in instalments. The seller of the asset keeps ownership of the asset until the last payment has been made, but makes the asset available to be used by the purchaser. The purchaser usually has the right to acquire the asset at the end of the contract. Conditional sale agreements operate in a similar way, with the title passing automatically to the purchaser once they have made the final payment.

Often such arrangements are treated as a finance lease for accounting purposes. Where a hire purchase contract or conditional sale agreement is treated as a finance lease in the accounts then the implicit financing cost would be included in tax-interest, as income for the seller and expense for the purchaser.

Buy Now Pay Later Agreement

Buy Now Pay Later (BNPL) is a model by which:

  • A customer purchases goods or services from a retailer,
  • The retailer receives payment immediately from the BNPL firm, less a BNPL fee, and
  • The customer has an interest-free debt with the BNPL firm, which is settled after a period of time.

Generally, a BNPL arrangement involves the following steps:

  1. At the point of sale of goods or services, the customer selects BNPL as the payment option, as an alternative to paying by debit or credit card.
  2. Once the purchase is made, the BNPL provider immediately assumes the customer’s debt obligation to the retailer and subsequently settles the balance to the retailer, less a BNPL fee. The BNPL provider assumes all credit risk related to any non-payment by the customer.
  3. The customer is required to pay back the purchase amount to the BNPL provider in instalments over a specified period. There is normally no interest charged, so the purchase price to the customer remains the same as if they had paid by debit or credit card.
  4. If the customer misses an instalment payment, they may be charged late payment fees and/or interest charges.

Any interest or fees charged by the BNPL provider to the customer for missing an instalment will be a relevant loan relationship credit (for the BNPL provider) and tax-interest income.

When considering the initial fee charged by the BNPL provider to the retailer, it is necessary to consider how much (if any) of this fee may be an implicit finance cost. This would normally be driven by the accounting for the arrangement.

For example, an element of the fee may be in respect of the time value of money or the BNPL’s credit risk in assuming the debt and therefore constitute a finance cost. Any element of the initial fee that is a finance cost (other than an impairment loss) will likely be a tax-interest expense amount for the retailer, and a tax-interest income amount for the BNPL provider, on the basis that the arrangement is a form of (or similar to) debt factoring.