CFM6370 - Taxing Loan relationships: anti-avoidance: shares as debt: S91D condition: unallowable purposes test

Unallowable purpose test

The third let out from S91D is where a company’s purpose in acquiring a share is not an unallowable purpose. This test is much the same as the well known general loan relationships unallowable purposes test in FA96/SCH9/PARA13 (see CFM6210), but with an important additional rule relating to ICTA88/S95 (taxation of dealers in relation to distributions). Circumvention of ICTA88/S95 is to be treated as an unallowable purpose, and in deciding whether that test is passed, there is a special rule for companies which are part of banking groups. This special rule has been inserted to make it more difficult for banking groups to avoid taxation on their lending returns by using preference share schemes.

FA96/S91D (9) provides that an investing company is treated as acquiring a share for an unallowable purpose if the purpose, or one of the main purposes, for which the company holds the share is –

• the purpose of circumventing ICTA88/S95, or
• any other purpose which is a tax avoidance purpose.

As with the general unallowable purposes test, a tax avoidance purpose, in the case of any company, means any purpose that consists in securing a tax advantage (whether for the company or any other person) within the meaning of ICTA88/S709(1).

Because dividends on UK shares are not normally chargeable to CT (ICTA88/S208), and no tax relief is given for payment of a dividend, the normal expectation is that an issue of shares between two UK resident members of the same group would not be caught by the unallowable purposes rule, because there would be no tax advantage. But that might not be the case where, for instance, a tax advantage arose as a result of one party being a financial trader. Each case must be considered on its own facts.

Banking groups: special rule

FA96/S91D (10) gives the special rule for banking groups. It provides that a company shall be taken to have the purpose, or one of the main purposes, of circumventing ICTA88/S95 if the investing company was an associated company of a bank at the time when it acquired the share, unless the investing company shows that –

• immediately before that time, some or all of its business consisted in making and holding investments, and
• it acquired the share in the ordinary course of that business.

A ‘bank’ has the meaning given by ICTA88/S840A, and associated company means a company within the same group within the meaning given by ICTA88/S413 (3)(a).

The reason for this additional rule is that banking groups have undertaken numerous and varied schemes to convert an interest lending return into something else for tax purposes, and so this rule provides additional safeguards. The logic is that a banking group is either trading or investing in relation to the shares it acquires.

If it can be shown that a share is being used to get around ICTA88/S95, then (provided the other conditions are met) condition 2 in S91D will apply to treat the share as a creditor loan relationship. If that cannot be shown, but the investing company is part of a banking group, then S91D will still apply unless the investing company can show that it acquired the share in the ordinary course of an investment business. Note that the onus is on the investing company to demonstrate that fact.

Although the wording in S91D(10)(a) refers to “immediately before that time” (i.e. the time the share was acquired by the investing company), HMRC staff should accept that the test is met (including the “in the ordinary course of that business” requirement) where the share is the first investment made by a company provided that they are satisfied the company has embarked on genuine investment business and the share is not being used to disguise lending arrangements. This includes cases where the company only intends to acquire a single investment.

In applying this test, it is not a requirement that a company's whole business consists in making and holding investments (FA96/S91D (10) (a) refers to "some or all of its business"). So it is possible for a financial trader such as a bank to hold a share as an investment. This will be a question of fact, but shares in subsidiaries are unlikely to be trading assets.