IFM40695 - Other tax issues: whether investments are non-commercial securities

Where a QAHC receives a return on a non-commercial security the amount of tax payable in the QAHC could be increased.

A “non-commercial security” is defined in CTA10/S1005 – see CTM15500. Any security issued by a company is a non-commercial security if the consideration given by the company under the security for the use of the principal secured by that security represents more than a reasonable commercial return for the use of that principial. Any interest or other distribution out of the assets of the company in respect of such securities, to the extent that it is in excess of such a reasonable commercial return, is treated as a distribution under CTA10/S1000(1)E. There is guidance on the meaning of “reasonable commercial return” at CTM15502.

As explained at IFM40720, a QAHC may be funded by a profit participating loan (PPL). The return on the PPL will typically be treated as an interest expense. If the QAHC uses the funds to invest in a non-commercial security then, as above, any amount the QAHC receives above the reasonable commercial return will be treated as a distribution. The result of this may be that the corporate interest restriction (CIR) applies to restrict the deduction available for the QAHC in respect of the interest on the PPL. This would increase the taxable profits of the QAHC.

Whether a return to the lender represents a commercial return for the amounts lent will depend on the facts and circumstances at the time the security is issued. In general, HMRC would consider that a security issued by an unconnected third party acting at arm’s length is unlikely to be a non-commercial security.

Example

A QAHC purchases securities issued by an unconnected securitisation vehicle on the open market. These securities constitute the “equity tranche” of notes issued by the securitisation vehicle. This means that the return on the securities is equal to the residual profits of the vehicle after all other tranches of notes have been repaid. Any other investor who acquired the securities would receive the same return. The fact that the security was issued by an unconnected borrower at arm’s length suggests that the return is a return which is reasonably commercial for the use of the principal secured by the security. Therefore, absent any unusual circumstances, HMRC would not expect CTA10/S1000(1)E to recharacterise any of the return on the securities as a distribution.