BN 18 - Protecting Revenues: Financial Products

Who is likely to be affected?

1. Companies who enter into certain types of arrangement that involve financial products designed to avoid tax.

General description of the measure

2. These measures block a number of avoidance schemes that have been notified to HM Revenue and Customs under the disclosure rules introduced in Finance Act 2004. A common feature of a number of these schemes ((d) to (g) below) is that they use intra-group arrangements to avoid tax on income arising to the group, or create a tax loss when there is no economic loss to the group as whole. Work will continue to examine the extent to which these and other similar themes are common to this type of avoidance scheme, and the scope for identifying a common approach to addressing them.

3. In order to tackle immediate issues, legislation will be introduced in the 2006 Finance Bill to block the following schemes:

a) avoidance of tax on interest on cash using stock lending arrangements on non-commercial terms;

b) arrangements involving purchase and sale of rights to distributions on shares used by financial traders to create tax losses;

c) avoidance of tax through use of instruments which are economically loans but which are claimed not to be loan relationships because they cannot be settled in cash (so called “mandatory convertibles”) but by the issue of shares;

d) exploitation of the group continuity rules for loan relationships and derivative contracts to take advantage of different accounting methods used by group companies, or to avoid tax on discount arising on transfers;

e) exploitation of accounting rules which result in profits on loan relationships being de-recognised, and thus falling out of tax;

f) avoidance of tax in respect of loan relationships under arrangements where the investor receives less than a full commercial lending return (which would be taxable), but another connected party receives the value of that return in a non-taxable form; and

g) regulations coming into force today will prevent arrangements to hedge currency exposures resulting in tax relief where there is a loss on the hedge but no tax charge where there is a profit.

4. In addition, minor changes will be made to the ‘shares as debt rules’ introduced in Finance (No 2) Act 2005, to clarify the wording and ensure they work as intended, and in one instance to provide a relaxation asked for by business.

Operative date

5. The changes apply to scheme (a) in respect of arrangements entered into on or after 5 December 2005, with transitional provisions where arrangements in force on that date are amended. The extension of the stock lending anti-avoidance rules to other arrangements which are similar to stock lending arrangements will apply to arrangements entered into on or after 22nd March 2006.

6. The changes apply to scheme (b) where sales of rights to distributions are made on or after 20 January 2006.

7. The changes apply to schemes (c), (e) and (f) in respect of profits accruing from 22nd March 2006, and to scheme (g) to exchange losses brought into account from 22nd March 2006.

8. The changes apply to scheme (d) in respect of transfers of loan relationships or derivative contracts on or after 22nd March 2006.

9. The changes to the ‘shares as debt rules’ will apply to profits accruing on or after today, and the relaxation of the time limit for issues of mirror shares will apply where the public issue is on or after 22nd March 2006.

Current law and proposed revisions

10. In outline, the proposed changes will block the schemes as follows:

a) a lender who provides cash collateral under a stock lending arrangement with no provision for manufactured payments will be treated as receiving interest on that cash at a commercial rate. In
addition, this treatment along with existing anti-avoidance legislation in section 736B Income and Corporation Taxes Act 1988 (“ICTA”) will be extended to non-commercial arrangements which are economically similar to stock lending arrangements;

b) the exemption from tax in section 730 ICTA on proceeds of sale or other realisation of the right to receive a distribution on shares will be removed;

c) arrangements involving the lending of money but which are not loan relationships solely because they cannot be settled in cash but by the issue of shares will be brought within the loan relationships regime in Chapter 2 Part 4 Finance Act 1996 (“FA 1996”);

d) the group continuity rules (paragraph 12 Schedule 9 FA 1996 and paragraph 28 Schedule 26 Finance Act 2002) will be amended to ensure that no profits fall out of account where assets are transferred under contrived arrangements designed to take advantage of the tax definition of ‘fair value’. And where discount arises on transfer of a loan relationship or derivative contract, that discount will not be prevented from being brought into account by the group continuity rules;

e) the loan relationship rules in Chapter 2 Part 4 FA 1996 will be amended in two ways. First, to ensure that in cases where the accounting treatment wholly or partly de-recognises profits or losses on loan relationships so that some or all of those profits or losses fall out of tax, the full amounts of those profits or losses must be brought into account for tax purposes;

f) second, where a company is party to a creditor loan relationship and does not receive interest, but a connected party receives the value of that interest in non-taxable form, then the creditor company is treated as receiving loan relationship profits equal to that non-taxable value;

g) regulations are being made that will disregard for tax purposes an exchange loss on a contrived hedging arrangement in circumstances where, had there been an exchange profit, that profit would have escaped tax; and

h) the wording of the ‘shares as debt rules’ will be amended to clarify the times when the sections apply, and to ensure the interaction of sections 91A and 91B FA 1996 works properly. The definition of ‘outstanding third party obligations’ in section 91A FA 1996 will be amended to prevent attempts to get around it. The meaning of ‘redeemable’ shares in section 91D FA 1996 will be extended to include guaranteed exit arrangements. The time limit for the issue of shares which mirror qualifying publicly-issued shares will be extended from 24 hours to seven days.

Further advice

11. If you have any questions about these changes, please contact Chris Kerr on 020 7147 2619 or Richard Thomas on 020 7147 2558.