IFM40760 - Treatment of certain payments: late interest

FA22/SCH2/PARA50

Under normal loan relationship rules, interest is relieved when it accrues in the accounts rather than when it is actually paid. This can lead to a mismatch where the lender is outside the loan relationship rules because the borrower will get relief when the interest accrues but the lender will not be taxed until the interest is paid. Where the lender and borrower are connected, this mismatch could be exploited to obtain a tax advantage.

CTA09/PT5/CH8 therefore introduces rules which mean that, where conditions are met, the borrower can only get a deduction when the interest is actually paid rather than when it accrues. CFM35800 has further guidance on these rules.

The late paid interest rules can be problematic for a QAHC which will often look to match interest income accruing on an investment with a corresponding interest expense accruing on shareholder debt. The accounts will show income and expense amounts which broadly net out. For taxation purposes, the late paid interest rules can deny a deduction for the expense when the interest is not actually paid within a certain timescale. This will often be the case where the QAHC either does not receive the interest income or chooses to reinvest it rather than return it to investors. The QAHC is therefore taxed in full on the interest income that accrues.

PARA 50 provides for this issue by disapplying the late paid interest rules to a ‘qualifying debit’. A debit will be a ‘qualifying debit’ provided it meets all of the following conditions:

  • It relates to interest payable under a debtor relationship of the QAHC;
  • The QAHC is party to that relationship for the purpose of its QAHC ring fence business;
  • The interest to which the debit relates accrues when the QAHC was a QAHC.
Example

Interest expense of £100 accrues on a QAHC’s shareholder debt on 1 January but is not paid. The QAHC leaves the regime on 31 March and then pays the interest on 15 April.

Provided the QAHC was party to the shareholder debt for the purpose of its QAHC ring fence business, the £100 interest accrual will be a ‘qualifying debit’. It can therefore be relieved for corporation tax purposes on 1 January because the late paid interest rules will be disapplied.

Even though the QAHC has left the regime when it actually pays the interest on 15 April, this payment will still relate to a ‘qualifying debit’ meaning a further deduction cannot be claimed at this time. This avoids a deduction double being given for the same expense.

Example

On the example above, if the interest arose on a mixed purpose loan, then a just and reasonable apportionment would be required per PARA 50(3). If £75 of the interest expense is attributable to the QAHC ring fence business then £75 will be relieved for tax on 1 January and £25 will be relieved on 15 April.

Example

Interest of £300 becomes due on 30 June which relates to the period 1 April to 30 June. The company leaves the QAHC regime on 31 May and the interest is paid on 18 September. £200 of the interest relates to the period in which the company was in the QAHC regime. During this time, the QAHC was party to the loan purely for the purpose of its QAHC ring fence business. This £200 is therefore a qualifying debit and will be relieved on the accruals basis. Because an accounting period will end when the QAHC leaves the regime on 31 May per PARA 31, this means an interest expense of £200 can be included in the tax computation for this period.

By contrast, the £100 balance cannot be relieved for tax until it is paid on 18 September.