OT22008 - Interest and Financing

OTO Commentary. Section 494 (2)(a)(i). "used to meet"

The legislation disallows a ring fence deduction for interest unless the money borrowed is used to meet qualifying North Sea expenditure. This may be an easier test to satisfy than a purpose test. Prior to FA96 it was possible for companies to argue that if money borrowed was originally used to meet such expenditure, the interest was eligible for a ring fence deduction even if the current purpose of the borrowing was something else.

However in looking at how money has been "used" in the application of S494 OTO considers that money is fungible (fungible - Concise Oxford Dictionary - "that can serve for, or be replaced by, another answering to the same definition"). That is, any £1 is as good as any other £1, or any $1 is the same as any other $1. Thus, the fact that money borrowed is put into a separate account from which funds are drawn to meet expenditure incurred by the company in carrying on oil extraction activities does not necessarily, in OTO’s view, mean that it passes the S494 test if there are other accounts available to the company out of which money is used for other purposes. In the limit it might be necessary to look at all money used in a period and all uses to which money is put in that period and apply uses to usage proportionately.

For accounting periods beginning on or after 1 April 1996, FA96 effectively introduces a trade purpose test, since under FA96/s82(2) a company can claim a trade deduction for interest only if it is party to a loan relationship for the purposes of its trade. If it is a party to the loan relationship for non-trade purposes then any non-trading debit must first be set against non- trading credits by virtue of FA96/s82(3), and any surplus non-trade deficit cannot be deducted against ring fence profits because of FA96/Sch8 para1(4) (though it is possible to set it against other trade profits).

For CTSA periods interest on borrowings to finance non-trade assets may be disallowable under Sch 28AA.

If it is claimed that money borrowed has been appropriated to meet expenditure incurred or to be incurred at a later date the Inspector will establish the facts including the specific expenditure identified. This will then be referred to the Assistant Director for consideration.