TTM07510 - The Ring Fence: Interaction of finance costs and transfer pricing: Intragroup interest-free loans
Examples
Background
The finance cost allocation rules operate to ensure that the deduction for finance costs allowable outside the ring fence does not exceed a just and reasonable proportion of the total external finance costs.
If the deduction outside the ring fence does exceed a just and reasonable proportion of the total external finance costs, then the rules work by introducing an additional amount chargeable to tax outside the ring fence.
But the transfer pricing rules will also introduce an additional charge outside the ring fence if there are any interest-free loans across the ring fence. Where a company (whether or not a tonnage tax company) lends money to a tonnage tax company in the same group for use in the tonnage tax trade, the lending is unlikely to be in the course of a tonnage tax trade, but the borrowing is for the purposes of a tonnage tax trade: hence the loan is across the ring fence and must be transfer priced.
Where the conditions are satisfied, the procedure described in TTM07500 will operate to ensure that the total additional amount chargeable to tax outside the ring fence (under the finance cost and transfer pricing rules) is no greater than is necessary to limit the net deduction for finance costs to a just and reasonable amount.
Practical approach
The approach to be adopted will depend on the circumstances of each case.
- Where interest has been imputed on loans across the ring fence, this should be taken into account when computing the finance cost adjustment.
In particular, it will normally be appropriate to reduce the amount of the finance cost adjustment that would otherwise have been made by an amount equal to the imputed interest.
See Example A below.
- If the amount of imputed interest is greater than the amount of the finance cost adjustment that would otherwise have been made, then (if the conditions of TTM07500 are satisfied) a negative finance cost adjustment (equal in amount to the difference between the two) may be made. In practice this means that finance costs of this amount that would otherwise have fallen within the ring fence may be deducted outside the ring fence.
In the extreme case where no finance cost adjustment would otherwise have been made, the additional amount of finance costs to be deducted outside the ring fence will be equal to the amount of the imputed interest.
See Example B below.
- In certain circumstances it may not be possible to limit the amount chargeable outside the ring fence to the appropriate amount by reducing the finance cost adjustment (as in a. above), or by allowing a further amount of finance costs to be deducted outside the ring fence (as in b. above). This will happen if the amount of imputed interest is greater than the total amount of the external finance costs.
In these exceptional circumstances, and if the conditions of TTM07500 are satisfied, HMRC would not seek to impose a charge on imputed interest, and the finance cost adjustment will fall to be calculated in the normal way.
See Example C below
Example A
| Description | Company | Description |
|---|---|---|
- |
Ibex Ltd (non-trading holding co.) |
External borrowing £1000 @ 10% |
| Loan £250 interest-free | - | Loan £750 interest-free |
| Shipping Ltd (pure tonnage tax co.) | - | General Ltd (non-tonnage tax co.) |
Assume that Shipping Ltd and General Ltd have equal capital requirements.
Before any transfer-pricing or finance cost adjustments, the whole of the group's external finance costs of £100 (£1000 @ 10%) are deductible outside the ring fence.
Step 1 - Impute interest on loans across the ring fence
The loan to Shipping Ltd is a loan across the ring fence.
Under the transfer pricing rules Ibex Ltd is assessable on imputed interest of:
£250 @ 10% = £25
Step 2 - Calculate the finance cost adjustment as if no interest had been imputed
As Shipping Ltd and General Ltd have equal capital requirements, the just and reasonable fraction is ½.
The finance cost adjustment is therefore:
£100 - (½ x £100) = £50.
Using the A - (F x B) formula.
Step 3 - Calculate the finance cost adjustment, taking account of the imputed interest
The finance cost adjustment that would otherwise have been made is reduced by the amount of interest imputed under the transfer pricing rules.
The finance cost adjustment actually falling to be made is therefore
£50 - £25 = £25.
The net result of these steps is that the net amount deductible outside the ring-fence is £50, made up of:
- £100 deduction for Ibex Ltd (external finance costs);
- £25 assessable on Ibex Ltd (interest imputed under the finance cost rules);
- £25 assessable on Shipping Ltd (finance cost adjustment).
There is no net charge to tax on imputed interest as the interest charge of £25 is matched by a reduction of £25 in the finance cost adjustment.
Example B
| Description | Company | Description |
|---|---|---|
| - | Ibex Ltd (non-trading holding co.) | External borrowing £1,000 @ 10% |
| Loan £750 interest-free | - | Loan £250 interest-free |
| Shipping Ltd (pure tonnage tax co.) | - | General Ltd (non-tonnage tax co.) |
Assume that Shipping Ltd and General Ltd have equal capital requirements.
Before any transfer-pricing or finance cost adjustments, the whole of the group's external finance costs of £100 (£1000 @ 10%) are deductible outside the ring fence.
Step 1 - Impute interest on loans across the ring fence
The loan to Shipping Ltd is a loan across the ring fence
Under the transfer pricing rules Ibex Ltd is assessable on imputed interest of:
£750 @ 10% = £75.
Step 2 - Calculate the finance cost adjustment as if no interest had been imputed
The just and reasonable fraction is ½.
The finance cost adjustment is therefore:
£100 - (½ x £100) = £50
Using the A - (F x B) formula.
Step 3 - Calculate the finance cost adjustment, taking account of the imputed interest
The finance cost adjustment that would otherwise have been made is reduced by the amount of interest imputed under the transfer pricing rules.
The finance cost adjustment actually falling to be made is therefore:
£50 - £75 = -£25
In accordance with TTM07500 a negative adjustment is permissible to the extent that it is required to eliminate the net charge to tax on imputed interest.
The net result of these steps is that the net amount deductible outside the ring-fence is £50, made up of:
- £100 deduction for Ibex Ltd (external finance costs);
- £75 assessable on Ibex Ltd (interest imputed under the finance cost rules);
- £25 deduction for Ibex Ltd (negative finance cost adjustment under TTM07500).
There is no net charge to tax on the imputed interest as the interest charge is matched by a reduction of £50 in the finance cost adjustment that would otherwise have been made, plus a negative finance cost adjustment of £25 (whereby a further £25 of external finance costs are allowed as a deduction outside the ring fence).
Example C
| Description | Company | Description |
|---|---|---|
| - | Ibex Ltd (non-trading holding co.) | External borrowing £100 @ 10% |
| Loan £250 interest-free | - | Loan £750 interest-free |
| Shipping Ltd (pure tonnage tax co) | - | General Ltd (non-tonnage tax co) |
Assume that Shipping Ltd and General Ltd have equal capital requirements.
Before any transfer-pricing or finance cost adjustments, the whole of the group's external finance costs of £10 (£100 @ 10%) are deductible outside the ring fence.
Step 1 - Impute interest on loans across the ring fence
The loan to Shipping Ltd is a loan across the ring fence.
Under the transfer pricing rules Ibex Ltd is assessable on imputed interest of:
£250 @ 10% = £25.
Step 2 - Calculate the finance cost adjustment as if no interest had been imputed
The just and reasonable fraction is ½.
The finance cost adjustment is therefore:
£10 - (½ x £10) = £5
Step 3 - Calculate the finance cost adjustment, taking account of the imputed interest
As the Imputed interest exceeds the amount of the finance cost adjustment, TTM07500 would normally permit a negative finance cost adjustment so the that imputed interest can be fully taken into account.
But the imputed interest also exceeds the external finance costs - and so it is not possible to avoid a net charge to tax on imputed interest by allowing an additional amount of external finance costs to be deducted outside the ring fence. In these exceptional circumstances, we would not seek to impute interest on the intra-group loans.
The net result of these steps is that the net amount deductible outside the ring-fence is £5, made up of:
- £10 deduction for Ibex Ltd (external finance costs);
- £5 assessable on Shipping Ltd (finance cost adjustment).
In this case there is no charge to tax on imputed interest, and the finance cost adjustment is calculated in the normal way.
References
| References | Links |
|---|---|
| Outline of transfer pricing | TTM07300 |
| Transfer pricing between companies | TTM07310 |
| Outline of finance costs adjustment | TTM07400 |
| Meaning of ‘finance costs’ | TTM07410 |
| Group companies’ finance costs | TTM07430 |
| Interaction of finance costs and transfer pricing | TTM07500 |