OT22100 - Interest and Financing

Interest Dependent on Results. Section 209(2)(e)(iii) ICTA 1988

ICTA 88/s209(2)(e)(iii) provides that where the amount of interest paid is dependent on the results of the company's business or any part of it, the interest is to be treated as a distribution.

Some companies finance development by means of Production Payment Agreements. These are loans where recourse is limited to the cash flow from an individual field. The rate of repayment of capital and interest is dependent on the field's cash flow and in some circumstances neither the full amount of the interest nor the principal will become due for payment/repayment. Recent technical advice on this type of loan is that the interest element of these payments falls within ICTA88/s209(2)(e)(iii) and should be treated as a distribution, subject to the override in ICTA88/s212.

Any amount of interest to which S209(2)(e)(iii) applies is excluded from the corporate debt rules of FA96 by FA96/Sch9/para1.

The rationale behind the treatment of production payments is that the liability to pay the interest depends on the profitability of the field concerned. This is different in nature from the ability to pay. If for example a company's results are so poor that it is unable to pay part of the interest due, that would not cause the interest to fall within s209(2)(e)(iii) as the liability remains. Similarly where an agreement for the payment of interest allows for the deferral of payment (e.g. if the production build up or other economic factors are worse than expected) that does not of itself lead to the application of s209(2)(e)(iii).

Section 209(2)(e)(vii) ICTA 1988 came into effect for payments from 14 May 1992 and broadly provides that interest payable under agreements which have either no set date or a very long date for repayment are to be reclassified as distributions.agreements which provide for repayment on demand are not caught.

The legislation is not intended to catch wholly commercial arrangements, particularly those entered into before the legislation was enacted. Provided that the payments have been taxed on the recipient, the OTO will only require that suitable wording is added to the agreement to take it outside the scope of 2(e)(vii).

The practice of writing 49 year agreements will not be caught by (e)(vii), but will not be commercial if there are no further qualifications to the duration. The application of s494 and the rest of s209 still need to be considered.

Any clearance issued would have a termination date in line with commercial practice for the trading activity.