Background Note
29.Index-linked gilt-edged securities (ILGs) are securities issued by the Government. They differ from conventional gilts in that both the interest payments and the principal payment are adjusted periodically in line with movements in inflation (as measured by RPI). Consequently, the holder is provided with inflation proofed income.
30.The corporation tax rules for ILGs ensure that their inflation proof quality is not impacted by tax. They achieve this by exempting from tax the adjustment in the accounts carrying value of an ILG to the extent that the adjustment relates to inflation (i.e. movements in RPI).
31.Some companies and groups in the financial sector have entered into avoidance schemes whereby a prima-facie exposure to ILGs is created, thereby triggering the exemption from tax, while ensuring that the exposure to the ILG is fully hedged in the market. The hedge is commonly a derivative, such as a total return swap that effectively eliminates all risk and reward in respect of holding the ILG. This means that while the company or group entering into the scheme remains economically flat, it manages to retain the tax advantage inherent in holding the ILG.
32.The purpose of these new provisions is to ensure that companies and groups undertaking transactions involving ILGs cannot benefit from the tax exemption to the extent that they are not economically exposed to the inflationary aspect because of the existence of a linked hedging arrangement.