GREIT04028 - Tax-exempt income: loan relationships and derivative contracts: partnership example

This example shows how loans made by partnerships of which the UK-REIT is a partner are treated. Company C has a 50% share of the profits of partnership P. C lends P 1,000,000 at 5%. C becomes a UK-REIT on 1 January 2007.

Loan relationship rules pre-REIT

The rules that normally apply where a corporate partner makes a loan to the business carried on by the partnership of which it is a member are in paragraph 19 Schedule 9 FA 1996. The partnership computes its profits without accounting for any loan relationship (LR) debits or credits, and these are apportioned to the corporate partners in line with their profit shares.

C’s tax computations for accounting period ending 31 December 2006 would show:

• LR credit of interest paid by partnership 50,000 – chargeable Schedule D Case III
• LR debit of 60% of the interest paid by P 30,000 – treated as non-trading LR debit
• These two figures are offset to give a net Schedule D Case III charge of 20,000.

After C becomes a UK-REIT

On and after 1 January 2007, C is divided for tax purposes into two companies; C (residual), which carries on taxable activities of C and C (tax-exempt), which carries on the tax-exempt property rental business of C.

The role of loan creditor belongs to C (residual) since making loans is not part of the property rental business.

C (residual)’s tax computations for accounting period ending 31 December 2007 would show:

LR credit of interest paid by partnership 50,000 – chargeable Schedule D Case III

As long as the borrowing by P is for the purposes of the tax-exempt business, the LR debits and credits are allowable as deductions in computing the profits of the tax-exempt business.

If the Schedule A profits of P are 650,000, C (tax-exempt)’s share of that is 390,000. From that will be deducted 30,000 (= 60% of 50,000 LR debit) leaving 360,000 as profits of C (tax- exempt).