On 9 November 2009, the Financial Secretary to the Treasury announced the Government's intention to make certain changes to the rules about tax treatment of the financing expenses and income of UK companies (the 'worldwide debt cap') which are in Schedule 15 Finance Act (FA) 2009. This is in response to comments and representations that have been made by businesses and their advisers since Finance Act 2009 became law.
Ministerial Statement of 9 November 2009 on Corporate Taxation (PDF 17K)
The purpose of this paper is to explain in more detail the changes that are to be made. The changes will have effect for periods of account of the worldwide group beginning on or after 1 January 2010, when the worldwide debt cap rules come into force. The legislation will therefore apply from the outset in its amended form. The amendments will be published in draft form with the 2009 Pre-Budget Report, for comment.
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The 'gateway test' in Part 2 of Schedule 15 works by comparing the sum of the UK net debt of each relevant group company (that have net liabilities) with the worldwide gross debt (relevant liabilities) of the group as whole. If the UK net debt exceeds 75 per cent of the worldwide gross debt, then the group is within the debt cap rules.
The debt cap rules use the same definition of relevant liabilities for the relevant group company and the worldwide group, and so where a UK company has external debt the same liability will be included in both the UK company accounts and the consolidated accounts. The UK measure is taken from the UK company accounts, which will in most cases be drawn up under UK generally accepted accounting practice (GAAP). The worldwide measure is taken from the consolidated accounts, which are likely to have been drawn up using another set of accounting standards, typically International Financial Reporting Standards (IFRS).
A particular liability may be treated differently under the different accounting standards. Indeed, it is possible for it to be treated differently even where consolidated accounts and single entity accounts are prepared under the same accounting standards. For example, borrowings may be measured at amortised cost in individual company accounts, but at fair value in consolidated accounts.
A group will be at a disadvantage if the value placed on a liability in single entity accounts is higher than in the group's consolidated accounts. This could switch the group from not meeting the 'more than 75 per cent' condition and so not falling within the debt cap rules to meeting the condition and so having to apply the full Schedule 15 rules. Equally, of course, the differing accounting treatment might work the other way. In either event, the operation of the 'gateway test' is distorted.
It is proposed to eliminate this distortion by ensuring that where a UK company has a 'relevant liability' that is also a relevant liability of the worldwide group (or part of such a relevant liability), a common standard of measurement is used for the purposes of the gateway test. The common standard will come from the consolidated accounts - so whatever value is placed on the liability in computing the gross debt of the worldwide group must also be used in computing the net debt amount of the UK company concerned.
This will have no effect on the measurement of intra-group debts owed by UK companies, which are eliminated on consolidation and are therefore not reflected in the worldwide gross debt.
The definition of 'relevant liabilities' in Part 2 - both for the worldwide group and for UK companies - refers to 'amounts borrowed'. It has been pointed out that the phrase may be wide enough to encompass issues of preference shares, even though dividend payments on preference shares are excluded from the calculation of the available amount by paragraph 73(2) Schedule 15.
To put the position beyond doubt, it is proposed to specifically exclude issues of preference shares from the definition of relevant liabilities (both for UK companies and for the worldwide group), and similarly to exclude subscriptions for or holdings of preference shares from being 'relevant assets' of UK companies when computing their net debt.
A group falls within the general exclusion from the worldwide debt cap for qualifying financial services groups if all, or substantially all, of either its UK or its worldwide trading income derives from 'qualifying activities'. These include relevant dealing in financial instruments (paragraph 8(c)). 'Financial instruments' are defined in paragraph 11(1) as anything that is a financial instrument for any purpose of the FSA Handbook.
HMRC has been advised, however, that a number of instruments in which banks commonly deal are not included within the FSA Handbook definition. For the avoidance of doubt, the Government proposes to broaden the definition to ensure that all dealings in derivatives are included, including those whose subject matter is non-financial (such as property or commodity derivatives) and those which result in physical delivery.
The Government intends to introduce a provision that will enable a company to elect to be an 'excluded company'. If a company is excluded, the group is debarred from allocating any part of a debt cap disallowance to that company, unless the UK group contains no non-excluded companies. If no statement of allocated disallowances is submitted and a 'default allocation' under paragraph 25 applies, an excluded company will not be included in that allocation. Any relevant group company may elect for exclusion, but where a group has appointed an authorised company to make Part 3 allocations, the authorised company must consent to the election.
This facility will benefit companies requiring certainty that no part of their interest costs will be disallowed under the debt cap, for example to protect their credit rating.
'Excluded company' treatment will apply mandatorily to dual resident investment companies.
A dual resident investment company (DRIC) is, broadly, an investment company that is resident in the UK through central management and control but also resident in another territory. If the company has a non-trading loan relationships deficit, section 404 Income and Corporation Tax Act (ICTA) 1988 prevents the deficit being group relieved. This prevents the same loss from being relieved both against profits of other UK group companies and in the overseas territory of residence.
To the extent that the non-trading deficit of a DRIC arises from financing expenses within the debt cap rules, absent treating a DRIC as an 'excluded company', a group could allocate any debt cap disallowance against the financing expenses of the DRIC (under Part 3 Schedule 15), while disregarding an equal amount of financing income elsewhere within the UK group. This could allow the group to sidestep the section 404 ICTA 1988 restriction.
'Financing income amounts' of a UK group company are defined in paragraph 55. It is proposed to extend this definition to include guarantee fees. This is because the payment of a guarantee fee will normally give rise to a loan relationship debit, as an expense of bringing a loan relationship into existence. However, receipt of the guarantee fee is not a loan relationship credit because it does not bring a loan relationship into existence for the guarantor.
Thus, where guarantee payments are made between group companies or are imputed between group companies under Schedule 28AA Income and Corporation Tax Act (ICTA) 1988, there is a mismatch in the operation of the debt cap rules where the guarantee fee is a financing expense for the payer but not financing income for the recipient. The change will correct this mismatch by including guarantee fees paid (or deemed to be paid under Schedule 28AA ICTA 1988) by another group company as a financing income amount of the recipient.
Schedule 15 includes, at paragraph 57, rules to exclude the financing expenses and financing income of group treasury companies from being taken into account in computing the tested expense amount and tested income amount. The rule is elective and requires all UK group companies that are group treasury companies to make an election if their expenses and income are to be ignored. HMRC has received representations that the rules as currently enacted will prevent some genuine treasury operations from being able to benefit from the exclusion.
Paragraph 58(8) provides that if there is more than one UK group company that undertakes treasury activities, their income is aggregated; and at least 90 per cent of this aggregate income must be 'group treasury revenue' (defined at paragraph 58(10)) before any of the companies qualifies as a group treasury company.
Frequently, however, a UK group company which does not serve a treasury function may nevertheless undertake some activities that are defined in paragraph 58(9) as treasury activities (for example, it may have surplus funds on deposit). The income of such 'quasi-treasury companies' must, as the legislation currently stands, be aggregated with that of any 'genuine' group treasury company when applying the 90 per cent test. Since a 'quasi-treasury company' will often have substantial non-treasury income (such as trading income) this may lead to the test being failed.
It is therefore intended to remove the requirement for income to be aggregated. The 90 per cent test will be applied separately to each UK group company which has income from treasury activities. Where more than one company in a UK group passes this test and falls within the definition of a group treasury company, the requirement in paragraph 58(4) remains : all group treasury companies must elect under paragraph 58(2) for an election by any one of them to be valid.
Paragraph 68 provides that where a company pays interest to various tax-exempt bodies, such as local authorities, the interest is not treated as a financing expense. This is because the recipient cannot get relief from tax by disregarding the receipt as financing income. Non-departmental public bodies, provided they are not within the charge to corporation tax, will be added to list of creditors to which this applies.
Paragraph 73(1)(d) permits 'amortisation of ancillary costs relating to amounts borrowed' to be included in the 'available amount' - the worldwide financing costs with which the tested expense amount of relevant group companies in the UK is compared. 'Ancillary costs' were intended to be fees and other direct costs of issuing securities or borrowing money. Some advisers, however, appear to be putting a much wider interpretation on the phrase, so that for example losses on derivatives used to hedge the borrowing might be represented as 'ancillary costs'.
It is therefore proposed to insert a definition of 'ancillary costs' within paragraph 73, which will be broadly be the same as the definition of allowable charges and expenses for loan relationships purposes found in section 307 Corporation Tax Act (CTA) 2009.
Where a UK company is a partner in a partnership, an appropriate share of the loan relationship debits and credits of the partnership is deemed to arise to the company and is included in its Corporation Tax Return (see Chapter 9 Part 5 CTA 2009). Borrowings by such a partnership will therefore increase the financing expense amounts of UK company partners for debt cap purposes. For accounting purposes, however, the finance costs included in the group's consolidated accounts in respect of that borrowing may be quite different - it will depend on how the group accounts for its interest in the partnership. The mismatch may work either for or against the taxpayer.
For example, suppose a UK company has a 20 per cent share in a partnership that pays external interest of £50 million each year. £10 million is treated as loan relationship debits of the company and is a financing expense amount, and hence included in the tested expense amount. But if the group accounts for its interest in the partnership as a portfolio investment, the finance costs shown in the consolidated accounts will not reflect the partnership borrowing at all. As a result, the £10 million is not included in the available amount as the partnership is not controlled by the group. The total disallowed amount is increased by £10 million.
It is intended to correct imbalances of this kind by providing that, where
financing costs are incurred by a partnership in which a relevant group company
is a partner,
any actual amounts disclosed by the consolidated accounts in respect of that
borrowing are disregarded. For the purposes of computing the available amount,
it will be replaced by an amount defined in statute.
This will be arrived at by dividing the partnership borrowing between all of the partners in the partnership (including non UK residents and non-corporates) in proportion to their profit shares. If, on this assumption, borrowing costs would feature in the group's consolidated accounts (in other words, if the partner concerned is a member of the group and the borrowing is not from another group member), these deemed borrowing costs will form part of the available amount.
The overall effect of this will be that the available amount, in so far as it relates to borrowing by the partnership, will reflect external borrowing costs reasonably attributable to group companies.
Paragraph 80(1)(d) precludes a collective investment scheme from being the ultimate parent of a group of companies. HMRC has, however, received representations that the definition of 'collective investment scheme' (CIS) in paragraph 80(2) is too narrow.
The definition relies on section 235 Financial Services and Markets Act (FISMA) 2000. This regulatory definition of a CIS is modified by regulations (SI 2001/1062) that prevent certain arrangements from being a CIS.
A UK Limited Liability Partnership (LLP) would come within the paragraph 81 definition of a corporate entity and is therefore capable of being the ultimate parent of a group, unless the CIS exemption at paragraph 80(1)(d) applies. Regulation 20 of SI 2001/1062 stops a body corporate (other than an open-ended investment company) from being a CIS, but an amendment introduced by SI 2001/3650 provides an exception for LLPs. This means that a UK LLP may, if it satisfies the regulatory requirements for being a CIS, come within the paragraph 80(1)(d) exclusion.
However, similar partnerships formed under the laws of other territories may likewise be corporate entities under paragraph 81, but cannot benefit from the section 80(1)(d) exclusion because, by virtue of regulation 20 of SI 2001/1062, they fall outside of the section 235 FISMA 2000 definition. This means that many corporate fund vehicles could be treated for debt cap purposes as being the ultimate parent of a 'supergroup' comprising several unrelated groups of companies.
It is therefore intended to modify the paragraph 80(2) definition to provide that where an entity would be a collective investment scheme within section 235 FISMA but for the fact that it is a body corporate, it is treated as being a CIS for the purposes of paragraph 80(1)(d).
In a securitisation a group will use a special purpose vehicle (SPV) as a means to raise finance. Assets will be transferred to the SPV and finance raised on the security of those assets. The income generated from the assets will be used to pay the finance expenses. The advantage to a group of raising finance using a securitisation is that it can be cheaper than raising finance directly on the financial markets.
Securitisation companies have their own tax regime in FA 2005 that for some securitisation companies result in the credits and debits in the accounts of the company being substituted by a statutorily computed level of chargeable profit. The Government's overall policy is that securitisation companies should be excluded from the debt cap rules. It is intended to achieve this by providing that securitisation companies are neither relevant group companies nor UK group companies for the purposes of Schedule 15.
The amendments should remove from the main debt cap rules both securitisation companies taxed under the permanent regime in SI 2006/3296, and those subject to the interim regime in section 83 FA 2005. It is intended, however, that securitisation companies, provided their results are included in the group's consolidated accounts, will still be taken into account when applying the gateway test in Part 2 Schedule 15, and in deciding whether a group is excluded from the regime as a qualifying financial services group.
Discussions are continuing with the securitisation industry to ensure that, when securitisation companies are excluded from the main debt cap rules in this way, the tested expense amount for the remainder of the group, and the available amount, are arrived at in a fair and consistent way.
Four sets of draft regulations were published for comment in June. These were:
HMRC and HM Treasury are grateful to all those who commented. It is expected that the first two of these sets of regulations, with some amendments as a result of consultation, will be laid before the end of the year and will come into force on 1 January 2010. The third set of regulations has already been laid, and will come in to force on 1 January 2010.
HMRC has, however, been advised that the fourth set of regulations (the Short Term Loan Relationships) Regulations could be interpreted as being ultra vires. It is therefore proposed to extend the relevant regulation-making power in Finance Bill 2010 and to lay these or substantially similar regulations, such that they have retrospective effect from 1 January 2010, once the Bill has received Royal Assent.
The computation of the available amount under paragraph 73 Schedule 15 takes into account, in respect of amounts borrowed, only interest and amortisation of discounts, premiums and ancillary costs. The definition of financing expense amounts of group companies in paragraph 54 is, however, wider and takes in all debits arising on loan relationships unless they are specifically excluded by paragraph 54(3).
This means that fair value changes in debtor loan relationships (whether they arise because the loan is the hedged item in a fair value hedge of interest rate risk, or because the liability is being measured at fair value), and 'notional finance costs' relating to issues of convertible securities may be taken into account when computing the tested expense amount, but not when computing the available amount.
Such mismatches may lead to anomalies in the application of the debt cap rules. HMRC and HM Treasury are looking at ways in which such mismatches can be eliminated, or their effects reduced. This is, however, a complex area. In particular, there is a need to strike a balance between achieving a like-for-like comparison between the available amount and the tested expense amount of a group, and the additional compliance burden that might be introduced by further refinement of the definitions.
It is therefore proposed that HMRC and HM Treasury will continue to consult on measures to ensure that this basic comparison gives a fair outcome. Any solution is, however, likely to involve detailed rules that are best provided in secondary legislation. Thus a new regulation-making power will be added to Schedule 15 by Finance Bill 2010. It is envisaged that the new power will enable the effect of regulations to be backdated to the beginning of the calendar year in which the regulations are made, so any changes introduced by regulations laid in 2010 will apply from 1 January 2010.
Paragraphs 54 (2) and 55 (2) Schedule 15 include as financing expense amounts and financing income amounts debits and credits 'brought into account in respect of a loan relationship', where such debits or credits would be brought into account under Part 3 or Part 5 of CTA 2009 (trading and non-trading respectively).
The phrase 'brought into account in respect of a loan relationship' has given rise to some uncertainty. In particular, some commentators have queried whether it includes financing arrangements, such as alternative finance arrangements (Islamic finance) and repos, which are treated as loan relationships under Part 6 of CTA 2009.
Section 294 CTA 2009 provides that references in the Taxes Acts to Part 5 include references to Part 6 (unless the context indicates otherwise). Moreover, specific provisions within Part 6 provide for particular matters to be treated as loan relationships. HMRC therefore takes the view that 'brought into account in respect of a loan relationship' includes amounts relating to such deemed loan relationships. On the other hand, amounts relating to derivative contracts are not (as has been suggested by certain commentators) financing expense amounts or finance income amounts of a company, because they are not 'in respect of a loan relationship', even though they may be charged under Part 5 CTA 2009.
This view will be included in guidance - no legislative change in this area is proposed.
Rules in Chapter 8 Part 5 CTA 2009 provide that, in certain circumstances, interest payable to related party is not deductible for tax purposes when it accrues, but only when it is paid. Changes made by FA 2009 mean that these 'late interest' rules (and related rules about discounts) apply less frequently than was previously the case.
Where they do apply, however, the effect on the debt cap rules is two-fold :
In neither case will there be any effect on the available amount.
It has been suggested that an 'accruals basis' should be applied for debt cap purposes, even where the late interest rules apply for tax. The Government has considered these representations carefully, but is not proposing any action on the point. In line with the overall policy behind the debt cap, a restriction on interest relief already made under some other tax rule is respected for debt cap purposes, so that the same interest is not (in effect) disallowed twice. The other side of the coin is that where tax rules increase the amount of interest for which relief is given, it is the tax-adjusted figure which is taken into account when computing any debt cap disallowance.
