CTM15505 - Distributions: general: interest or other value in respect of securities - reasonable commercial return - examples
ICTA88/S209 (2)(d)
1. Fixed interest rate loan issued at par
A security is issued for a term of 1 year at £100 with a coupon at a commercial rate of 5%. The investor receives £105 at the end of the year.
ICTA88/S209 (2)(d) will not bite. The return (5%) for the principal secured (£100) is commercially reasonable.
2. Fixed interest loan issued at a premium
A security with a par value of £100 is issued for a term of one year, at a premium of £2, for £102. The coupon is at a commercial rate of 7.1% to recognise the fact that £2 capital will not be returned. The investor receives £107.10 at the end of the year.
Before 1 April 1996
The principal secured is £100. Interest of 5% represents a reasonable commercial rate of return for this amount and, therefore, the additional amount of £2.10 represents a return above what is commercially reasonable for the use of the principal secured. For distributions made before 1 April 1996, the sum of £2.10 would be the amount of the distribution under ICTA88/S209 (2)(d).
On or after 1 April 1996
The return by reference to the principal secured plus the premium is £5.10 (£107.10 less £102). £102 @ 5% equates to £5.10, which constitutes an aggregate commercial rate of interest under ICTA88/S209 (3A) for the principal secured, and for the premium. The provision applies for distributions made on or after 1 April 1996 unless ICTA88/S209 (3AA) applies on or after 17 April 2002.
On or after 17 April 2002
For distributions on or after 17 April 2002, ICTA88/S209 (3AA) will apply if all the conditions within ICTA88/S209A and ICTA88/S209B are met. Under this provision, the principal secured is treated as the new consideration of £102. A return of £5.10, which is 5% of £102, is commercially reasonable for the use of the principal secured and therefore no distribution arises under ICTA88/S209 (2)(d).
It should be noted that ICTA88/S209 (2)(d) would still apply to the excessive return, notwithstanding the application of ICTA88/S209 (3A) or ICTA88/S209 (3AA), if the rate in the example were 7% and a reasonable commercial rate was 5%.
3. Stock index-linked loan, return of subscription guaranteed
A security is issued for a term of one year at £100. The return is £100 plus 70% of any rise in the stock index.
There is no risk that the lender will lose any of the subscribed amount and therefore the prospect of 70% of any rise in the stock index, which is freely traded on the markets, is a reasonable commercial return. ICTA88/S209 (2)(d) will not re-characterise any of the return as a distribution.
4. Stock index-linked loan, strengthening market, low guaranteed returned amount
A security is issued for a term of one year at £100. The outlook for a rising stock index appears strong, but there can, of course, be no guarantee of this.
If the stock index falls, the investor will receive:
- the amount invested less the reduced value of the amount invested as calculated by the reduction in value of the stock index, with a guaranteed minimum amount returned of 1% of the amount invested.
If the stock index rises, the investor will receive:
- the amount invested and 80% of the rise in the stock index.
Distributions prior to 17 April 2002.
There is no premium on issue of the security and, therefore, the principal secured is £1 (the guaranteed minimum of 1% of the issue price). Almost all the return compared with principal secured of £1 will be above a reasonable commercial return and accordingly almost all the amount received by the lender above £1 will be a distribution under ICTA88/S209 (2)(d). If, for example, the security paid £105 on maturity, £104 would be a distribution under ICTA88/S209 (2)(d).
Distributions on or after 17 April 2002
For distributions on or after 17 April 2002, ICTA88/S209 (3AA) may apply. In practice, this is unlikely unless the issuer is a bank or securities house. If it applies, the principal secured will become £100. The index reflects the value of stock traded on the open market and a return less than the amount of that increase (less reasonable expenses of management of the investment) would be a reasonable commercial return. This is because at the outset the lender can only expect a maximum of the return that the commercial markets provide. ICTA88/S209 (2)(d) would not, therefore, apply in the above example (though it would apply to any return above a reasonable return).
Note
Each of the distribution provisions must be considered independently.
In cases where ICTA88/S209 (2)(d) does not apply, because of the application of ICTA88/S209 (3AA), the provisions of ICTA88/S209 (2)(e)(iii) should be borne in mind.
The loan relationships provisions will apply if the return is treated as interest.
