Finance Act 2009

Finance Act 2009

2009 CHAPTER 10

Introduction

Section 41 Schedule 20: Loan Relationships Involving Connected Parties

Summary

1. Section 41 and Schedule 20 amend the corporation tax rules on loan relationships that apply to connected parties. In certain circumstances, these rules restrict the tax deduction for interest or discount payable on a loan or security, until the interest is paid or the security is redeemed. Under the amended rules, where the connected party to which the interest or discount is payable is a company, such a restriction will be made only where the company is located in a “non-qualifying territory”. The change applies for accounting periods beginning on or after 1 April 2009.

Details of the Schedule

2. Paragraph 2 amends section 374 of the Corporation Tax Act 2009 (CTA). This section applies where interest payable between companies that are “connected” (as defined in the loan relationships rules) is paid more than 12 months after the end of the accounting period in which it accrues, and the creditor company is not taxable under the loan relationships rules. In such cases, the interest is allowable for tax purposes only when it is paid. Paragraph 2 amends this rule by inserting new subsection (1A) and new subsection (3) in section 374.

3. New subsection (1A) sets out a new condition for section 374 of CTA to apply. This condition is that the creditor company must be resident for tax purposes in a “non-qualifying territory” or effectively managed in a “non-taxing non-qualifying territory” when the interest accrues.

4. New subsection (3) defines terms used in new subsection (1A). “Resident” for these purposes means liable to tax in a territory by reason of domicile, residence or place of management. “Non–qualifying territory” means a territory with which the UK does not have a double taxation agreement, or where there is such an agreement, it does not contain a non-discrimination provision. A “non-taxing non-qualifying territory” means one that does not impose tax by reason of domicile, residence or place of management. The territories to which these definitions apply are, broadly, tax havens.

5. Paragraph 3 amends section 375 of CTA. These sections apply where interest payable on loans made to close companies by participators in those companies is paid more than 12 months after the end of the accounting period in which it accrues, and the creditor is a company that is not taxable under the loan relationships rules. In such cases, the interest is allowable for tax purposes only when it is paid. Paragraph 3 amends this rule by inserting new subsection (4A) in section 375. The amendment does not affect the tax treatment of interest paid to a participator who is not a company, for example an individual shareholder.

6. New subsection (4A) sets out a new condition, the “non-qualifying territory condition” (similar to that in new subsection (1A) in section 374 of CTA) for section 375 to apply.

7. Paragraph 4 amends section 376 of CTA which provides interpretation of section 375 of CTA. It inserts definitions of “resident” and “non-taxing non-qualifying territory” for the purposes of section 375 of CTA which correspond to the definitions that apply for the purposes of new subsection (1A) in section 374 of CTA. Because these definitions apply to the whole of section 375 of CTA, the new definition of “resident” will also apply to subsections (3) and (4) of section 375 of CTA. These subsections deal with exemptions from the section 375 rule where the debt is owed to certain close companies or limited partnerships.

8. Paragraph 5 amends section 377 of CTA. This section applies where interest payable on loans made between companies having a “major interest” (as defined in the loan relationships rules) in each other is paid more than 12 months after the end of the accounting period in which it accrues, and the creditor company is not taxable under the loan relationships rules. In such cases, the interest is allowable for tax purposes only when it is paid. Paragraph 5 amends this rule by inserting new subsection (2) in section 377, which sets out a new condition (similar to that in new subsection 1A in section 374 of CTA) for section 377 of CTA to apply. The definitions of the terms used in this condition similarly correspond to those in new subsection (3) in section 374 of CTA.

9. Paragraph 6 amends section 407 of CTA. This section applies where a discount accrues on deeply discounted securities issued between companies that are “connected” (as defined in the loan relationships rules) and the creditor company is not taxable within the loan relationships rules. In such cases, the discount is allowable for tax purposes only when the security is redeemed. Paragraph 6 amends this rule by inserting new subsection (1A) in section 407 of CTA, which sets out a new condition (similar to that in new subsection 1A in section 374 of CTA) for section 407 of CTA to apply. The definitions of the terms used in this condition similarly correspond to those in new subsection (3) in section 374 of CTA.

10. Paragraph 7 amends sections 409 of CTA. This section applies where a discount accrues on deeply discounted securities issued by a company to a close company participator, and the creditor is a company that is not taxable within the loan relationships rules. In such cases, the discount is allowable for tax purposes only when the security is redeemed. Paragraph 7 provides that this rule applies only where the “non-qualifying territory condition” is met.

11. Paragraph 8 amends section 410 of CTA by inserting new subsection (4A) which sets out the “non-qualifying territory condition”. This condition, and its associated definitions, mirror those in new subsections (1A) and (3) in section 374 of CTA.

12. Paragraph 9 sets out the commencement and transitional provisions for the amendments made by the Schedule. The changes have effect for accounting periods beginning on or after 1 April 2009. However, a company may elect, in its corporation tax return for the first accounting period beginning on or after that date, for the amendments not to have effect for that period. Where it does so, the current rules will apply instead. No election may be made for an accounting period ending after 31 March 2011.

Background Note

13. Under the corporation tax rules on “loan relationships”, interest, discount and other profits, gains, losses and expenses arising on loans and similar financial instruments are normally taxed and relieved in accordance with amounts recognised in accounts drawn up under generally accepted accounting practice (an “accruals basis”). However, this principle is modified in a number of circumstances where there are transactions between connected parties. These circumstances include cases involving late payments of interest and discounts, in order to prevent manipulation which might result in a deduction for such interest or discount by a debtor company, where no corresponding amounts are taxed as a receipt of the creditor company.

14. The current rules operate by allowing a tax deduction for late interest and discounts in certain cases where the parties are connected and the creditor is taxable outside the loan relationships rules, only when the interest is paid or when the deeply discounted security is redeemed (a “paid basis”).

15. Recent decisions of the European Court of Justice have raised the question of whether the legislation as it currently stands is compatible with European law. HMRC issued a consultation document in July 2008 in which options for changes to the rules were presented. The changes set out in the Schedule are based on responses to the consultation. The effect of the changes is that where the connected creditor is a company, the “paid basis” will apply only if that company is resident or effectively managed in a “non-qualifying territory”, which broadly means a tax haven. In all other cases where the connected creditor is a company, the normal loan relationships “accruals basis” will apply.