INTM610170 - Exception Conditions: Tax Mismatch: Qualifying Deduction and Qualifying Loss Relief

Paragraph 6(7) Schedule 4 Finance Act 2019 defines qualifying deduction and qualifying loss relief for the purposes of the tax mismatch condition as follows.

A “qualifying deduction” is one made in respect of the overseas party’s actual expenditure that does not arise directly from the arrangements and for which the resident party would have obtained a deduction against a relevant tax if it had incurred the expenditure. It must not exceed the amount of any deduction that the resident party would have obtained.

“Qualifying loss relief” is any permissible means of using a loss for corporation tax purposes to reduce the amount on which the overseas party is charged to tax. For a non-UK resident company it is any corresponding means of using a loss to reduce the overseas party’s liability to a tax corresponding to corporation tax. Those losses may either be those of the overseas party or ones surrendered to it by another company.

Example 16 – Qualifying Deduction

This example illustrates what is meant by a qualifying deduction.

As part of a material provision, the overseas party acquires IP from the resident party and then charges royalties to the resident party for its continued use. The overseas party amortises the amount paid for the IP, which is allowable as a deduction in computing the overseas party’s liability. This is not a qualifying deduction because it arises from the making of the material provision.

Example 17 – Qualifying Deductions and Qualifying Losses

The effect of the rules on qualifying deductions and qualifying loss relief is to give a consistent comparison between the tax positions of the two parties.

If the resident party pays £100 to the overseas party for something that costs the overseas party £95 to provide then the comparison would not be expected to be between the tax effect on the resident party of its paying £100 and the tax payable by the overseas party on a net £5 (calculated as the amount they received for this thing (£100) less the amount it cost them to provide it (£95)). As long as the £95 costs of the overseas party meet the criteria of a qualifying deduction the comparison is between two amounts of £100.

However, if in another situation the overseas party was only taxed on £50 of the £100 because of some particular relief for £50 given in its country of residence that does not meet the qualifying deduction criteria then the comparison will be between the resident party’s reduction of tax on expenditure of £100 and what would have been the overseas party’s liability to relevant tax had its taxable income been £50.

Similarly, with loss relief, a reduction below £100 in the taxation of the receipt would not be taken into account to the extent that it relates to qualifying loss relief. But a loss is a qualifying one only if it corresponds to a loss for which the resident party could have obtained relief, so a loss that could be utilised under the law applicable to the overseas party but not to the resident party would not qualify.

If, for example, the resident party is a UK company making a payment to a non-UK resident group company that has no resulting increase in relevant taxes because it can set off brought forward losses of other group companies as well as its own against the relevant profits, only the element of loss relief that corresponds to what would be eligible under the UK rules would be qualifying loss relief.