INTM509140 – Intra-group funding cross border: avoidance and arbitrage

Spotting arbitrage

Spotting arbitrage is difficult because

• there are rarely any obvious indications in the tax returns made in one jurisdiction that a particular transaction may be part of a scheme designed to exploit asymmetries between different jurisdictions
• Inspectors in any given jurisdiction will not necessarily consider how a particular transaction is taxed in another jurisdiction. Almost certainly the taxpayer in that jurisdiction will not volunteer this information and Inspectors will only seek it out where they appreciate its potential importance and the amounts are large enough to make it worthwhile
• even if an Inspector does spot an example of arbitrage involving cross-border finance there may be little, if anything, that can be done to counter it. And there is therefore less incentive to seek it out in the first place.

However there are certain pointers which Inspectors should bear in mind and which may indicate that they are dealing with an attempt to gain different treatment for tax purposes in different jurisdictions. These include:

• the use of hybrid instruments (securities having characteristics of both debt and equity which could be treated differently in the respective jurisdictions) such as redeemable preference shares or the presence of hybrid entities within a group structure. These are entities which are regarded as opaque (taxed as a corporate entity) in one jurisdiction but regarded as transparent (taxed as a branch or partnership) in another – for example unlimited companies or entities that have chosen their particular tax treatment under the US 'check-the-box' regulations
• the presence of dual resident companies.

It is not possible to supply an exhaustive list of features to look out for, as arbitrage is something which, by its very nature, is always taking new forms. Therefore an Inspector who is dealing with any substantial case involving the provision of cross-border finance should always seek to ascertain how the transaction is viewed in the other territory. The group can be asked to provide this information. When dealing with a US group the Inspector should ask what elections have been made under the US check the box regulations. The 2005 Arbitrage legislation may well be helpful in challenging hybrid entities and instruments. Guidance is currently on the HM Revenue & Customs website.

An Inspector may meet with resistance when trying to ascertain the foreign tax position in a particular case. In cases where the relevant information is not provided voluntarily, it may be that the Exchange of Information provisions within a particular double taxation agreement can be invoked to obtain the information. For advice on how and when to make such a request, see INTM156000 and also INTM462090.