The introduction of the new loan relationships rules of Finance
Act 1996 and the move to a general accruals basis of taxation
reduced the scope for avoidance involving simple exploitation of
asymmetries.
The move to an accruals basis of taxation of interest has an
additional effect for the way we deal with loans made by UK
companies to overseas affiliates. Where the terms of such a loan
differ from those which would have been entered into between
parties dealing at arm's length, general transfer-pricing
principles will apply to impute interest income. Thus, in the case
of an interest free loan by a UK company to a non-resident
affiliate, we can use ICTA88/SCH28AA (and for pre-CTSA periods
ICTA88/S770) to impute a market rate of interest.
However, under the Finance Act 96 rules, interest on loans
from connected parties has to be brought into charge to tax as it
accrues. The consequences of this for outward loans to connected
parties are that, whenever a UK company loans money at interest to
an overseas affiliate, that interest will be brought into charge as
it accrues - whether or not it is actually paid and whether or not
the overseas company is in a position to pay it. What is imputed is
the amount that would have accrued (rather than been received) at
arm’s length. There is no provision for the UK company to get
relief for any tax it thereby suffers should the interest never be
paid. The only situation where the UK company can obtain relief
would be where, (as discussed in the chapter at
INTM503000) under the terms of a tax
treaty, we decide that it is appropriate to view the loan as equity
for tax purposes.
Accounting rules necessarily allow some flexibility in how
transactions should be recorded. Such flexibility means that the
straight-line basis of accruals (that is, one which records
interest or discounts as they accrue uniformly on a daily basis)
may not be considered the most appropriate method. This may be
particularly the case with deferred interest and discounts. The
above conditions allow us to ensure that interest and discounts are
taxed at the appropriate time. The Thin Cap/Arbitrage Group at CT
& VAT, International CT would be particularly interested to see
any cases where companies claim that the straight line basis of
accruals is not the appropriate basis for a loan made to an
overseas affiliate.
