INTM509030 – Intra-group funding: avoidance and arbitrage

Loan relationships for unallowable purposes: general

FA96/SCH9/PARA13 is an important anti-avoidance provision. It disallows deductions for interest, etc., to the extent that the loan is for an unallowable purpose. This is defined as one that is not within the business or commercial purposes of the company. Such a purpose specifically includes activities not within the charge to Corporation Tax and tax avoidance to the extent that obtaining a tax advantage was the main, or one of the main, purposes of the loan.

As with ICTA88/S787, ministerial guidance was given on how this provision would be used (see INTM509060). It broadly confirmed that genuine commercial loans would not be caught. Tax motivated loans, however, are vulnerable. As with ICTA88/S787, the Thin Cap Team at CT & VAT, International CT should always be consulted before the section is used in relation to cross-border transactions. The Anti-Avoidance Group has assumed responsibility for overall policy and domestic operation of the legislation. See the Corporate Finance Manual at CFM6210 for more guidance.

The provision disallows any debits where in an accounting period a loan relationship has an unallowable purpose. However, it disallows them only to the extent that, on a just and reasonable apportionment, the debits relate to the unallowable purpose.

For an accounting period, a loan relationship has an unallowable purpose if a company is party to it or has entered into a related transaction in relation to it for an unallowable purpose, under FA96/SCH9/PARA13 (2). The term ‘related transaction’ has the effect of broadening the scope of the loan relationship rules and is defined in FA96/S84(5) as any disposal in whole or part of rights or liabilities under that relationship. It can therefore potentially apply to any debits, for instance, representing

• interest payable or accrued due
• accrued discount
• a decrease in the value taken into account under an authorised mark-to-market basis
• the creation or increase in a provision in respect of or the writing off of a bad doubtful debt
• the release of a debt
• a loss on ceasing to be party to a debt, whether by disposal or otherwise.

However, it can only apply to the extent that, on a just and reasonable apportionment, the debit is attributable to the unallowable purpose.

Forex

For exchange gains and losses, Finance Act 1993 contained specific anti-avoidance rules at sections 135-138. But these were repealed in 2002 along with the rest of the Forex legislation.

There are now new rules introduced by Finance Act 2002 and they apply to accounting periods beginning on or after 1 October 2002.

The unallowable purposes provision in FA96/SCH9/PARA13 now also applies to exchange gains or losses arising on loan relationships that are for unallowable purposes, which includes a tax avoidance purpose. Both exchange gains and exchange losses are ignored where the loan relationship is for an unallowable purpose. Detailed guidance is to be found at CFM9830.

Derivative contracts

For derivative contracts FA02/SCH26/PARA23 reproduces the unallowable purposes provision introduced for loan relationships by FA2002. The rule applies with effect from 26 July 2001.

If a derivative contract is made for an unallowable purpose, any debits are disregarded for tax purposes, except to the extent that any net loss on the contract can be carried forward and set against future credits from the same contract. Exchange credits on such contracts are also disregarded, and there are special rules for taxing credits where debits on the same derivative contract have previously been disallowed. There are also provisions which apply if a company transfers value to a connected company by letting a valuable option expire; or if a company makes, in certain circumstances, interest-like payments under a derivative contract to a non- UK resident.

Detailed guidance is to be found at CFM13610 onwards.