SAIM2740 - What is disguised interest: the determining factors: the practical likelihood of the return

Disguised interest: the practical likelihood of the return

When viewed at the ‘relevant time, there must be ‘no practical likelihood’, other than the risk of insolvency or similar contingencies, that the arrangement will not produce the interest-like return. The ‘relevant time’ is the later of the time when the person becomes party to the arrangements, and when the return begins to be produced.

Thus, it must be clear at the outset that the return will be produced. There is no express requirement for the arrangement to be ‘designed’ to produce the return, but the return must be initially predictable. It is not enough that an interest-like return results from the arrangements. If the return is the product of chance or could not have been reasonably anticipated at the outset of the arrangements, then it cannot be a return that is ‘economically equivalent to interest’.

In assessing the ‘practical likelihood’ of the return, contingencies beyond the control of the parties, such as the theoretical possibility that the producer will be unable to pay the return, should therefore be ignored. These contingencies include the insolvency of the producer, and similar negligible risks. Commercially irrelevant contingencies which are part of the arrangements are also excluded from the consideration of whether there is a practical likelihood that the return will cease to be produced. This is in line with the approach taken in the judgment of the House of Lords in Scottish Provident Institution (76TC538).

Other possible risks, such as the risk that an investment portfolio might collapse, will not automatically mean that there is a practical likelihood that the return will cease to be produced and that there is therefore no disguised interest return. However, a disguised interest arrangement must meet all the other conditions in ITTOA05/S381A(4) in order to be within the provisions in the first instance. An investment portfolio that is genuinely exposed to investment risk is unlikely to provide a return that is economically equivalent to interest, regardless of whether it also meets the terms of the exemption for ‘excluded shares’ (SAIM2770).

The key questions to ask when considering this issue will be about the expectations and intentions of the parties.