Anti-avoidance measure regarding interest relief

Draft Legislation and Explanatory Statement

These notes include, supplement and explain the details of the draft legislation

The FST has announced that legislation will be introduced in the forthcoming Finance Bill to block avoidance schemes have been notified to HMRC that exploit provisions under which individuals may claim relief for interest payments on loans used to invest in partnerships or small companies.

This note provides an explanatory commentary and sets out the background to the changes.

The interest relief rules encourage investment in certain small businesses carried on commercially and with a view to profit. The return on a normal investment in such a business would not be a guaranteed one such that after deducting obligations under the loan from sums to which the investment gives rise the investor was certain to be able to exit with a profit. But in the schemes notified to HMRC arrangements are in place that mean that after the availability of the interest relief for the interest is taken into account the investor cannot fail to make a profit.

The new measure will deny relief for interest if the loan is made as part of arrangements that are certain (ignoring insignificant risk) to produce a profit for the investor by virtue of the interest being eligible for relief. It will not affect genuine commercial investments in business where there is uncertainty as to the return that will be produced from the arrangements.

HMRC welcomes representations on the draft legislation that has been published and is happy to consider any cases where it is considered that the draft legislation may inappropriately deny relief for interest paid.

Representations should be directed to:

Richard Rogers
CT & VAT Product & Process
3rd Floor,
100 Parliament Street
London SW1A 2BQ
Tel: 020 7147 2625
Or by email to Richard Rogers

Paragraph 1: Interest payments: arrangements appearing very likely to produce post-tax advantage

Paragraph 1 of the draft Schedule inserts new subsections (1A) to (1K) into section 384 of Income Tax Act 2007 (General restrictions on relief for interest payments) .

Section 384 restricts tax relief for certain interest payments made by individuals that would otherwise be deductible in computing their total taxable income.

New subsection (1A) provides that relief will not be available for interest paid by a person on a loan if the loan is made as part of arrangements which appear very likely to produce a "post tax advantage".

Subsection (1B) provides that paragraph (1A) will apply if (and only) it would be reasonable to assume from either or both of the likely effect of the arrangements or the circumstances in which they or any part of them is entered into that there is no more than an insignificant risk that the arrangements will not produce a post-tax advantage.

Subsection (1C) defines what is meant by "produce a post-tax advantage". It means that the arrangements will produce an amount payable to the borrower or a connected person (or to someone else for the benefit of the borrower or person connected with the borrower) of an amount (or aggregate amount) that after making the appropriate tax adjustments is at least equal to the amount needed to meet the borrower’s obligations (in respect of interest and principal) under the loan.

"Appropriate tax adjustment" is defined in subsection (1G) and (1H). The adjustment ensures that the value of the tax relief for the interest (due apart from the new rule) is taking into account in determining the amount payable to the person (and that additional tax payable by the person as a result of the arrangements is also taken into account).

This is intended to ensure that relief for interest is not available in any case where there is no more than an insignificant risk that obligations of the borrower in respect of the borrowing will not be satisfied by payments to which the wider scheme arrangements give rise The new measure will thus deny relief for interest if the loan is made as part of arrangements that are certain (ignoring insignificant risk) to produce a post-tax surplus for the investor by virtue of the interest being eligible for relief. The legislation will not catch genuine commercial investments in business where there is real uncertainty as to whether the level of return will secure a post-tax surplus for the investor.

Subsection (1D) and (1E) are anti-falsifying provisions. They ensure that the legislation will still apply if the arrangements include provision to secure that in the event of a post-tax advantage not being produced an amount not significantly less will still arise. Thus, the legislation would still apply if the arrangements gave rise to a say 30% (more than insignificant) chance of a post tax advantage not being produced if in that event the investor is still certain to receive an amount not significantly less. This reflects the fact that an avoider may be willing to live with significant risk or a trivial loss if the alternative outcome produces a significant profit.

Subsection (1F) ensures that a sum is treated as payable to a person if that person directly or indirectly receives the benefit of any asset. In any such case, the sum treated as payable to the person is equal to the value of the asset.

Subsection (1G) explains how to make the "appropriate tax adjustments" for the purpose of subsection (1C) or (1E). If "A" exceeds "B" the excess is to be deducted from the amount produced. If B exceeds A the excess is to be added to the amount produced.

Subsection (1H) defines "A" and "B". "A" is the aggregate amount of any income tax, capital gains tax or tax under the law of a territory outside the UK to which the borrower becomes liable as a result of the arrangements. "B" is the aggregate amount by which the borrower’s liability to income tax and capital gains tax would be reduced in consequence of the arrangements. This includes but is not limited to reduction in tax resulting from a claim under the interest relief provisions. For this purpose it is to be assumed that relief for the interest is not blocked by subsection (1A).

Subsection (1I) provides that "arrangements" means arrangements consisting of any number of agreements, understandings, schemes, transactions or other arrangements and apart from in subsections (1J) and (1K) also includes any related transaction.

Subsection (1J) defines "related transaction" as a transaction that it would be reasonable to assume would not have been entered into or effected independently of the arrangements. Thus, a hedging agreement would be a related transaction in relation to a borrowing or investment if it would be reasonable to assume that the hedge would not have been taken out apart from the loan or investment.

Subsection (1K) clarifies that transactions are not prevented from being related just because the transactions are not between the same parties or not between parties to the arrangements.

Much of this wording, as well as that in subsection (1J) and some of that in subsection (1B), is taken from the "guaranteed return provisions" in sections 559 to 566 of the Income Tax (Trading and Other Income) Act 2005 (previously Schedule 5AA of ICTA).

Paragraph 1(2) provides that the amendment has effect in relation to interest paid on or after 19 March 2009.