TTM07470 - The Ring Fence: Finance cost adjustment
The examples below are designed to demonstrate how a just and reasonable result might be reached. They are not exhaustive and are necessarily simplified.
A A tonnage group carries out wholly qualifying shipping operations and all income and expenses (including £100 finance costs) are accounted for within the tonnage tax ring-fence.
In this situation there are no activities outside the ring-fence and therefore neither paragraph 61 nor paragraph 62 applies.
B The same situation as A, except that the £100 finance costs are borne outside the tonnage tax ring-fence, and the group now has £100 of interest income outside the ring-fence. This interest income is negligible when compared to the rest of the group's activities and therefore any funding used to support the interest bearing deposit will also be negligible.
This means that F is 0% so E is 100. The net result is taxable income outside the ring-fence of £100.
C The same situation as B, except now the £100 of interest income is material to the group, representing 10% of its total income.
It might now be reasonable to regard some of the debt as funding the interest bearing deposit, and therefore F increases to (say) 10% and E reduces to 90.
D The same situation as C, except the £100 of interest income now represents 10% of the group’s total profits but only a negligible proportion of its total income.
A just and reasonable view might be that the funding applicable to the interest bearing deposit is negligible compared to the funding for the business as a whole, giving the result that F is 0% and E is 100.
E A tonnage tax group contains two UK companies, one of which is a tonnage tax company carrying out wholly qualifying shipping operations and the other of which is not a tonnage tax company. Both businesses are of similar size with similar funding requirements and therefore it is appropriate for F to be 50%. Each company incurs £100 finance costs, of which the tonnage tax company’s are inside the ring fence.
In this situation A = 100 and B = 200. This means that E = 0 and no adjustment is required.
F The same situation as E, except that the tonnage tax company is now wholly equity funded and all the finance costs have been charged in the non-tonnage tax company.
Now A = 200, B = 200, F = 50%, and therefore E = 100.
G The same situation as F, except that the tonnage tax group is a single company with two divisions. The finance costs are charged equally inside and outside the ring-fence.
There is already an equal sharing of finance costs on either side of the ring-fence, so E = 0.
H A tonnage tax company decides to increase its borrowings at the same time as it acquires a non-tonnage tax company. Finance costs are £100. Before this borrowing, the group was entirely equity funded. The two businesses are of similar size and with similar funding requirements. The group takes the full £100 into account in computing its profits outside the ring fence.
The principle of fungibility means that the finance costs must be regarded as relating to both businesses. Thus, F = 50%, and A = 100, B = 100 and therefore E = 50.
I A tonnage tax group consists of three companies: one is a tonnage tax company carrying out wholly qualifying shipping operations, another is an overseas company qualifying to pay dividends under the provisions of paragraph 49 and the other is a UK non-shipping company. All three businesses are of similar size and with similar funding requirements. Finance costs of £900 are all taken into account in computing the profits of the non-shipping company. Non-tonnage tax activities account for one third of the group.
The paragraph 49 company counts as tonnage tax for this purpose therefore F = 33%. This means that A = 900, B = 900 and E = 600.
J The same situation as I, except that the finance costs are charged £375 in each UK company and £150 overseas.
This means that A = 375, B = 750 and F = 33% giving E = 125. It can be seen that this gives a net UK deduction of 250/750 outside the ring-fence, which is proportionately the same as the 300/900 in example I. This satisfies the principal at 10(ii) and takes proper account of the fact that overseas debt reduces the extent of the group's UK source financing requirement.
K The same situation as J, except that the non-shipping company is now an overseas company.
This means that A = 0, B = 375 and E = 0 (E cannot be negative).
L The same situation as J, except that additional finance costs of £150 are paid by the non-tonnage tax company to the tonnage tax company.
The interest does not constitute trading income and is therefore taxed outside the ring-fence. A still = 375 (as the additional costs can be ignored), B still = 750 and F = 33% giving E = 125 (as in J).
M The same situation as L, except that the additional finance costs of £150 are paid by the non-tonnage tax UK company to the overseas shipping subsidiary.
A = 525 (the additional costs are now brought into account), B = 900 and F = 33% giving E = 225.
N Mrs X controls a group of UK non-tonnage tax companies that are funded primarily by debt. Her husband controls a group of tonnage tax companies that are funded primarily by equity.
The debt and finance costs in the Mrs X companies must be taken account of in the paragraph 62 calculations.
O A tonnage tax group incurs UK finance costs of £100 outside the ring-fence. F is determined at 2/3 which means that E = 33.3. The group enters into a financing arrangement whereby equity is invested in a subsidiary in a low tax regime and funds loaned back from this subsidiary to a tonnage tax company.
There are no additional commercial activities created by this transaction and prima facie, F remains at 2/3. Interest paid by the tonnage tax company to the overseas finance company increases B but has no impact on A, thus reducing E. The main benefit of this arrangement to the group is to avoid an additional tax charge. The Inland Revenue would view this as not being a just and reasonable result and would expect a further adjustment to be made.
Finance costs of group companies