BIM45820 - Specific deductions: incidental costs of loan finance: exclusions from relief
Currency movements, premiums/discounts on loan stock and
stamp duty
ITTOIA/S58 (4) specifically excludes the following items from the relief for incidental costs of loan finance:
(a) sums paid because of losses resulting from movements in the rate of exchange between different currencies,
(b) sums paid for the purpose of protecting against such losses,
(c) the cost of repaying a loan or loan stock so far as attributable to its being repayable at a premium or having been obtained or issued at a discount, and
(d) stamp duty.
Premiums and break charges
Some loans include terms under which the interest charged is at
a lower annual rate in the early years of the term and increases
later. A borrower who wishes to repay early will have to pay the
lender a charge (called break charges in this guidance).
It is sometimes suggested that break charges are allowable
under ITTOIA/S58 because sub- section (4) refers to “expenses
…. which are incurred wholly and exclusively for the purpose
of obtaining the finance, providing security for it or repaying
it”. However whether break charges are incidental costs of
loan finance within ITTOIA/S58 (2) will depend on the facts of the
particular arrangement. If such charges amount to a premium, they
are expressly disallowed by sub-section (4).
‘Premium’ is not defined for the purposes of
ITTOIA/S58, nor is there any judicial guidance on its meaning. We
might, therefore, expect the Courts to look to other sources
– other legal contexts, dictionary definitions, common usage
and so on – for assistance.
In common usage a premium usually connotes a payment made at
above par. In the context of loans, this would mean some excess
over the amount advanced. Although such excess may in certain
circumstances represent interest (Lomax v Peter Dixon & Son Ltd
[1943] 25TC353) that is not the case with break charges. It is
sometimes argued that break payments are interest because they may
be calculated by reference to interest that the lender might have
received had the loan continued. Interest is payment by time for
the use of money (Bennett v Ogston [1930] 15TC374). Break payments
are made to terminate the loan; they are not for using the money
over time.
A payment exacted on termination, whether or not provided for
in the original loan, may be a premium if it is not interest. The
way the agreement describes the sum is irrelevant. The issue is the
reality of the transaction, not the labels the parties attach to
it. Whether the payment in question is considered specifically
within the loan agreement or provided for elsewhere is not
determinative.
What is the nature of the break payment?
The majority of break payments that take the form of a
penalty for early redemption of the loan will represent bona fide
compensation to the lender. In such circumstances the break payment
will not amount to a premium and will therefore attract relief as
“incidental costs of raising loan finance”. Most High
Street lenders commonly require such break payments as a condition
of advancing finance. However there is no intention at the outset
for a premium to be paid, that more capital is repaid than
originally advanced. Instead any break fee received is
compensatory.
The Special Commissioners Case of Kato Kagaku Co Ltd (SPC598)
considered the issue of premiums. The decision of the Special
Commissioners is not a legally binding precedent, however it does
provide useful insight into the question of when a break fee may or
may not be a premium. In Kato an indemnity payment was provided for
within the loan agreement.. HMRC contended under the terms of the
loan agreement that a larger sum had to be repaid than the original
sum borrowed, therefore the difference was a premium within what
was Section 77 (7) (b). However the Commissioner’s judgement
reproduced in part below took a different view.
On sub-s (7)(b), the issue is whether
'premium' is used either (1) in a technical sense of the terms of
issue of a loan requiring repayment of a loan to be of a greater
sum than was borrowed, whether that amount is fixed or calculated
according to a formula, or (2) in a more general sense of anything
paid in excess of that borrowed which was applied in R v Delmayne
[1970] 2 QB 170 connection with the Protection of Depositors Act
1963, where protection of the public requires a wide meaning to be
given to 'premium'. In the context of 'being repayable at a premium
or to its having been obtained or issued at a discount' it seems to
me that 'premium' is being used in the former technical sense that
is customarily used in relation to loans. Clause 8.1 of the
agreement provides that 'The Borrower may prepay the loan in whole
or in part, without penalty, on any Interest Payment Date.'. I do
not consider that a corporate finance expert reading the words of
sub-s (7)(b) and those words of the agreement would consider that
the loan was repayable at a premium because the indemnity payment
for terminating the swap transaction was required to be made in
consequence of the prepayment.
Most commercial loans will incorporate a break payment
clause, which does no more than provide for compensating the lender
in the event that costs arise or interest is forgone upon early
redemption and relief will be available in these circumstances.
However it may, as a question of fact, be that particular
individual loan arrangements may provide for a payment to be made,
which although described as a break payment is in fact a premium.
The following characteristics may be indicative, but are likely to
be confined to schemes contrived for the purposes of Avoidance,
with substantial sums being present,
- The loan agreement is one of a number of transactions within
the arrangement
- The borrower and lender are connected
- The rate of Interest under the terms of the loan agreement is
demonstrably un- commercial for either party
- The break payment is disproportionately high in comparison to
the Principal or Interest
- The break payment was not contingent or solely contingent upon
early redemption
- Early redemption is predetermined
Consideration in such circumstances should be given to whether
the payment described is in the nature of compensation, or in the
nature of a premium where the intent was to repay more than the
original Principal, and therefore not deductible by virtue of the
exclusion at S58 (4) (c) on premiums. It should also be remembered
that to be allowable such payments would by virtue of S58 (2) have
to be “wholly and exclusively for the purposes of obtaining
the finance, providing security for it or repaying it”.
Enquiries into worthwhile cases should ensure that all
relevant facts and documentation are obtained before challenging
the deduction
