INTM509020 – Intra-group funding: avoidance and arbitrage

Loan relationships: the accruals regime

Finance Act 1996 saw a major change in the taxation of companies’ financial transactions with a comprehensive accruals (or, for some cases, mark-to-market) regime being introduced.

Before 1996 the rules had generally been based on the arising concept (for the taxation of income) and the payments concept (for relieving expenses). Pressure had been applied for many years to change from a system rooted in 19th century concepts to one that better reflected the differing commercial and economic characteristics of the modern world.

The main changes were

• the move from relief for interest by way of charges on income to one by way of deductions on an authorised accounting basis (under either Case I or Case III)
• the move from an arising basis of charge to an accruals (or in some cases, a mark-to- market) basis
• the move from a capital and revenue basis to an all-income basis.

The rules were further refined in Finance Act 2002 (see the Corporate Finance Manual from CFM5001 onwards).

Connected companies and cross-border transactions

The introduction of a comprehensive accruals regime necessitated the introduction of specific provisions for connected party and cross-border transactions so as to minimise avoidance opportunities. The principal exceptions to the general rules are

• if interest (or a discount on a relevant discounted security) is not paid within 12 months of the end of the accounting period in which it accrued, and the interest is not brought within the charge to UK corporation tax, the debtor cannot get a deduction for the interest until the accounting period in which the interest is actually paid. This is obviously of particular relevance to loans made to UK companies by non-resident affiliates
• for loans between connected companies (except in very limited circumstances), the lender is not allowed any relief for bad debts (nor, on the other hand, is the borrower charged to tax on any release of an obligation under the loan)

There is more about the rules for late paid interest and connected party bad debt at CFM5500- 5700.