IFM40720 - Treatment of certain payments: distributions

FA22/SCH2/PARA44

Broadly, the distributions legislation at CTA10/PT23 ensures that if a company passes value to one of its shareholders, without that shareholder giving full consideration in return, there will be a ‘distribution’ for tax purposes for both the company making the transfer and the recipient. The company making the payment will not recognise a deduction in respect of the distribution and the recipient may be charged to tax on the receipt. CTA10/PT23 contains detailed rules for determining whether there has been distribution and, if so, of how much.

For example, where a payment is made in respect of a ‘special security’ (as defined by CTA10/S1015) then the rules may treat this as a distribution rather than, say, interest and the company is denied a deduction for corporation tax purposes. Further guidance on distributions can be found at CTM15000.

Applying the distributions legislation without modification would cause issues in the context of the QAHC regime. Looking at a simple example, an investor lends money to a QAHC via a profit participating loan (PPL) with the QAHC using the funds to invest in a creditor relationship which falls within the QAHC ring fence (IFM40350).

A PPL is used because the return on it depends on the results of the company’s business. If the investment generates income, this can then easily be passed back to the investor under the terms of the PPL. The accounts for the QAHC will likely show the income that arises on the investment and then an expense that accrues under the PPL, leaving the QAHC broadly flat.

The PPL will be a ‘special security’ for the purposes of the distributions legislation because it will meet Condition C of CTA10/S1015. It might also meet the definition of a ‘non-commercial security’ at CTA10/S1005. Either of these sections can treat a payment made under the PPL as a distribution meaning a deduction is denied such that the income remains fully taxable in the QAHC. A similar issue can arise where a convertible security is used to fund the QAHC rather than a PPL.

To prevent such issues, PARA 44 states that a ‘relevant distribution’ is not to be treated as a distribution if the QAHC is party to it for the purposes of its QAHC ring-fence business. A ‘relevant distribution’ is any interest or distribution that arises on a ‘relevant security’. A ‘relevant security’ means:

  • Any security which meets Condition B, C or D of CTA10/S1015 (but does not meet Condition A or E); or
  • Any security which meets the definition of a ‘non-commercial security’ at CTA10/S1005.

Where a company is party to a security partly for the purpose of its QAHC ring fence business and partly for another purpose, PARA 44(5) allows a just and reasonable apportionment of the distribution. The element that relates to the QAHC ring fence business will be a ‘relevant distribution’.

This treatment will follow through to the holder of the debt instrument in that the receipt will not be treated as a distribution either. Where the investor is a UK corporate, for example, there should be a corresponding loan relationship credit which would be taxable.