CFM96320 - Interest restriction: related parties: ordinary independent financing arrangements by banks and others

TIOPA10/S470

Where two entities are treated by the rules to be related (for example where the 25% investment threshold is met) any loan advanced between them will prima facie be treated as related party debt. This will typically give the correct result but there will be circumstances where the loan was made totally independent of the fact that the debtor and creditor are related. Where this is the case, the loan will have been advanced on normal commercial terms meaning the financing arrangements will not be designed to confer a tax benefit.

S470 caters for such situations by treating certain loans as not made between related parties. It can only apply where the creditor is not party to the loan, directly or indirectly, as a result of any of the circumstances which make the parties related.

This treatment only applies in respect of the loan which meets this criteria and, for all other purposes, debtor and creditor will remain related parties.

Example One

A Ltd acquires a 30% stake in Z Ltd through its investment business. A Ltd and Z Ltd are therefore related parties by virtue of S463(7) because the 25% investment condition has been met.

Z Ltd requires additional finance to expand its business and funds this with a loan from B Ltd, a company in the same group as A Ltd which undertakes a lending business. Absent S470, this loan would be treated as made between related parties because the rights held by A Ltd are attributed to B Ltd. However, since the investment business acts independently from the lending arm (and because the loan was not advanced as a result of the existing connection), the loan is treated as not being between related parties.

Example Two

A person (Person X) has a minority interest in a credit fund (Alpha LP) of less than 25%. Alpha LP has a wholly owned subsidiary called Lender Ltd. Person X also has a minority interest (less than 25%) in a private equity fund (Beta LP). The management of Alpha LP and Beta LP is not coordinated. 

Beta LP has a controlling interest in Topco Ltd, the parent company of an investee group. Topco Ltd has an indirect wholly owned subsidiary called Borrower Ltd.

Lender Ltd lends £1m to Borrower Ltd.

Alpha LP and Beta LP are both limited partnerships. Person X is treated as connected with each of the other investors in Alpha LP and Beta LP, and attributed their rights and interests when applying the 25% investment condition (S465(1)). As a result, Lender Ltd and Borrower Ltd meet the 25% investment condition. The £1m loan is therefore treated as related party debt under the general rules.

S470 will engage to treat Lender Ltd and Borrower Ltd as unrelated parties in respect of the loan provided Lender Ltd is not party to the loan as a result of the person having an interest in both funds. This is likely to be the case where the person has a small stake, as here with Person X, and this plays no part in Lender Ltd’s decision to lend to Borrower Ltd. This is also likely to be the case since the management of Alpha LP and Beta LP is not co-ordinated.

S470 would not apply if, for whatever reason, the loan was made because of Person X's investments in Alpha LP and Beta LP. This might be the case, for example, where the loan was put in place at their request.