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Clause 415: Loan relationships with embedded derivatives

1237.     Where GAAP requires separate treatment of a loan relationship and its embedded derivative, this clause enables the loan relationship to be treated separately for the purposes of this Part also. It is based on section 94A(1) and (2) of FA 1996.

1238.     Clause 585 in Part 7 (derivative contracts) rewrites as much of section 94A of FA 1996 as deals with the treatment of embedded derivatives under Schedule 26 to FA 2002.

Clause 416: Election for application of sections 415 and 585

1239.     This clause permits a company subject to old UK GAAP to make an election to apply the treatment allowed under clause 415 even though separate treatment of loan relationship and derivative does not apply under that accounting policy. It is based on paragraph 7(1), (1A), (3), (4), (6) and (7) of Schedule 6 to F(No 2)A 2005.

Clause 417: Further provisions about elections under section 416

1240.     This paragraph makes further provisions about elections under clause 416. It is based on paragraph 7(2), (3) and (5) of Schedule 6 to F(No 2)A 2005.

Clause 418: Loan relationships treated differently by connected debtor and creditor

1241.     This clause applies where connected companies are debtor and creditor to a loan relationship which is treated as bifurcated by the debtor but not by the creditor. It is based on section 94B(1) to (6) of FA 1996. Where the debits brought into account by the debtor exceed the credits brought into account by the creditor additional credits must be brought into account by the creditor.

Clause 419: Section 418: supplementary

1242.     This clause explains terms used in clause 418. It is based on section 94B(7) to (10) of FA 1996.

Clause 420: Assumptions where options etc apply

1243.     This clause deals with loan relationships accounted for under an amortised cost basis which are affected by options after the end of the accounting period. It is based on paragraph 3(1) and (2) of Schedule 9 to FA 1996. The debits and credits to be brought into account under this Part are those which would arise if the option were exercised in the way most favourable to the party to the loan relationship.

Chapter 13: European cross-border transfers of business

Overview

1244.     This Chapter gives the rules that apply for loan relationships in the case of cross-border transfers of business within the European Community which is carried in the United Kingdom.

Clause 421: Introduction to Chapter

1245.     This clause sets out the two conditions required for the Chapter to apply together with the claim requirement. It is based on paragraphs 12D(1) to (4), 12G(1) and (2), 12H(1) and 12J(1) of Schedule 9 to FA 1996.

1246.     Subsection (3)(c) rewrites paragraph 12D(1)(d) - that the transferee is resident in the United Kingdom or within the corporation tax charge in section 11 of ICTA - as “within the charge to corporation tax” since the effect is the same.

Clause 422: Transfer of loan relationship at notional carrying value

1247.     This clause provides the rule that where either of the conditions in clause 421 applies, credits and debits on loan relationships which are transferred as part of the business transfer are brought into account by both the transferor and transferee as if the loan relationships had been transferred at the carrying value in the accounts of the transferor. It is based on paragraph 12D(1), (2) and (6) of Schedule 9 to FA 1996.

1248.     The definition of “notional carrying value” is taken from paragraph 12(2) of Schedule 9 to FA 1996.

Clause 423: Transferor using fair value accounting

1249.     This clause provides the rule to apply in place of clause 422 where the transferor company uses fair value accounting. It is based on paragraph 12D(7) of Schedule 9 to FA 1996 (which applies paragraph 12(2A) of that Schedule).

Clause 424: Reorganisations involving loan relationships

1250.     This clause provides for debits and credits to be brought into account as if the relevant loan relationships were disposed of at their carrying value where a reorganisation under sections 127 to 130 of TCGA arises as a result of a transfer of business within this Chapter. It is based on paragraph 12G(1), (2), (4) and (6) of Schedule 9 to FA 1996.

Clause 425: Original holder using fair value accounting

1251.     This clause provides the rule to apply in place of the rule in clause 424 where fair value accounting is used by the original holder. It is based on paragraph 12G(5) of Schedule 9 to FA 1996 (which applies paragraph 12(2A) of that Schedule).

Clause 426: Tax avoidance etc

1252.     This clause disapplies the Chapter if the transfer of business is not effected for genuine commercial reasons unless the Commissioners for HMRC are satisfied, following an application, that the Chapter should apply. It is based on paragraph 12F(1) and (2) of Schedule 9 to FA 1996.

1253.     In subsection (1)(a) “bona fide commercial reasons” is rewritten as “genuine commercial reasons”.

Clause 427: Procedure on application for clearance

1254.     This clause gives the rules that apply where a clearance application is made under clause 426 to the Commissioners for HMRC. It is based on paragraph 12F(3) of Schedule 9 to FA 1996.

1255.     Paragraph 12F(3) applies the rules in section 138(2) to (5) of TCGA which this and the following clause write out in full.

Clause 428: Decision on application for clearance

1256.     This clause gives the time limit within which HMRC must give a decision following a clearance application and procedures relating to appeals. It is based on paragraph 12F(3) of Schedule 9 to FA 1996.

Clause 429: Disapplication of Chapter where transparent entities involved

1257.     This clause disapplies the Chapter under certain circumstances where transparent entities are involved in the transfer of business. It is based on paragraphs 12H(1) and (2) and 12J(1) of Schedule 9 to FA 1996.

1258.     The last two words of paragraph 12H(2)(b) (“paragraph 12G does not apply in relation to it”) are not rewritten in subsection (2) because it is not considered that they add anything to paragraph (b). These words do not appear in paragraph 12H(2)(a) which states simply that “paragraph .. 12G [does] not apply to the transfer”.

Clause 430: Interpretation

1259.     This clause defines company and company residence in a member State for the purposes of the Chapter. It is based on paragraph 12J of Schedule 9 to FA 1996.

Chapter 14: European cross-border mergers

Overview

1260.     This Chapter gives the rules that apply for loan relationships in the case of mergers where the merging companies are resident in different member States of the European Community.

Clause 431: Introduction to Chapter

1261.     This clause sets out the conditions (which include the different categories of merger) under which the Chapter applies. It is based on paragraphs 12B(1) and (2) and 12I(1) of Schedule 9 to FA 1996.

1262.     Subsection (6) rewrites paragraph 12B(2)(c) - that the transferee is resident in the United Kingdom or within the corporation tax charge in section 11 of ICTA - as “within the charge to corporation tax” since the effect is the same.

Clause 432: Meaning of “the transferee” and “transferor”

1263.     This clause gives the meaning of the two terms for the different categories of merger set out in clause 431(3). It is based on paragraph 12B(9) of Schedule 9 to FA 1996.

Clause 433: Transfer of loan relationship at notional carrying value

1264.     This clause provides the rule that debits and credits on loan relationships transferred under the merger are brought into account as if the transfer had been for a consideration of an amount equal to the carrying value in the transferor company’s or companies’ accounts. It is based on paragraph 12B(3) of Schedule 9 to FA 1996.

Clause 434: Transferor using fair value accounting

1265.     This clause provides the rule to apply in place of clause 433 where the transferor company uses fair value accounting. It is based on paragraph 12B(4) of Schedule 9 to FA 1996 (which applies paragraph 12(2A) of that Schedule).

Clause 435: Reorganisations involving loan relationships

1266.     This clause provides for continuity of treatment in respect of loan relationships where a reorganisation under sections 127 to 130 of TCGA arises as a result of a merger within this Chapter. It is based on paragraph 12G(1), (2), (4) and (6) of Schedule 9 to FA 1996. Credits and debits are brought into account as if the loan relationships within the reorganisation were disposed of at their carrying value in the accounts of the company which holds them.

Clause 436: Original holder using fair value accounting

1267.     This clause provides the rule to apply in place of the rule in clause 435 where fair value accounting is used by the original holder. It is based on paragraph 12G(5) of Schedule 9 to FA 1996 (which applies paragraph 12(2A) of that Schedule).

Clause 437: Tax avoidance etc

1268.     This clause disapplies the Chapter if the merger is not effected for genuine commercial reasons unless the Commissioners for HMRC are satisfied, following an application, that the Chapter should apply. It is based on paragraph 12B(6) to (8) of Schedule 9 to FA 1996.

Clause 438: Disapplication of Chapter where transparent entities involved

1269.     This clause disapplies the Chapter under certain circumstances where transparent entities are involved in the merger. It is based on paragraphs 12I(1) and (2) and 12J(1) of Schedule 9 to FA 1996.

1270.     Paragraph 12I(2)(b) provides that paragraph 12G shall not apply in relation to shares or debentures issued by the transparent entity. This has been rewritten in subsection (3) to the effect that clauses 435 and 436 do not apply to the new holding.

Clause 439: Interpretation

1271.     This clause defines some terms used in the Chapter. It is based on paragraphs 12B(9) and 12J of Schedule 9 to FA 1996.

Chapter 15: Tax avoidance

Overview

This Chapter brings together provisions which counter avoidance, including avoidance which arises because transactions are not at arm’s length.

Clause 440: Overview of Chapter

1272.     This clause explains what the Chapter is about and the provisions it contains. It is new.

Clause 441: Loan relationships for unallowable purposes

1273.     This clause prevents a company from bringing into account debits in respect of a loan relationship with an “unallowable purpose” (defined in the following clause) or exchange gains on such a loan relationship. It is based on paragraph 13(1) and (1A) of Schedule 9 to FA 1996. Once such debits or credits are disallowed they are not brought into account for any other tax purposes.

Clause 442: Meaning of “unallowable purpose”

1274.     This clause gives the meaning of “unallowable purpose” for clause 441. It is based on paragraph 13(2) to (5) of Schedule 9 to FA 1996.

Clause 443: Restriction of relief for interest where tax relief schemes involved

1275.     This clause prevents a company from bringing into account debits for interest paid as part of a scheme or arrangements, the sole or main benefit of which is the obtaining of the debit for that interest. It is based on section 787 of ICTA.

1276.     Section 787 differs from paragraph 13 of Schedule 9 to FA 1996, rewritten in clauses 441 and 442, in the following ways:

  • paragraph 13 covers all debits and not just interest;

  • paragraph 13 looks at the purposes of a loan relationship and section 787 at the benefit that might be expected to accrue from a scheme or arrangements;

  • where section 787 is in point the whole of the interest is disallowed whereas paragraph 13 restricts only so much of the debit on the loan relationship as on a just and reasonable apportionment is attributable to the unallowable purpose.

1277.     For these reasons both paragraph 13 of Schedule 9 to FA 1996 and section 787 of ICTA are rewritten in full.

1278.     Section 787(1A) of ICTA requires the reference in section 787(1) to giving relief in respect of a payment of interest to be read “as including” a debit for interest under Chapter 2 of Part 4 of FA 1996 (loan relationships). This must be interpreted as applying that subsection to loan relationships alone as debits for interest are only allowed under Chapter 2 of Part 4 of FA 1996 (section 337A(2)(a) of ICTA). Subsection (1) is worded accordingly.

Clause 444: Transactions not at arm’s length: general

1279.     This and the following seven clauses provide rules for where transactions in respect of a loan relationship are not on arm’s length terms. It is based on section 103(1) of, and paragraph 11(1) to (3A) of Schedule 9 to, FA 1996. The clause requires debits and credits to be determined as if the related transaction in respect of which they arise were on arm’s length terms. Exchange gains and losses are not affected. Schedule 28AA to ICTA (provision not at arm’s length) has priority where it also applies (see clause 445).

1280.     Paragraph 11(2) refers to debits arising from the acquisition of rights under a loan relationship. The 1996 notes on clauses read “..[paragraph 11] specifically does not affect the buyer when it has paid less than the market price - we are quite happy when it comes to sell the loan relationship, in computing the profit, it only gets the amount it actually paid taken into account at cost rather than market value”. When the company comes to sell the loan relationship the transaction may not be at arm’s length, but the arm’s length value is clearly still intended to apply.

1281.     It was therefore intended that the debits refer to the entries in the asset account on the acquisition of a loan relationship acquired at below market value.

1282.     Paragraph 6204 of the Corporate Finance Manual reads:

(2) provides that the Para 11(1) adjustment does not apply to debits arising from the purchase of a loan relationship at less than market value.

Although this rule is primarily aimed at cases where the vendor is not within the charge to corporation tax, it does apply in other cases too. So, when a company buys a debt at undervalue (not at arm’s length), there is no adjustment in its accounts; it brings in the lower value and is taxed on the full amount of any resulting profit. Para 11(1) does apply to the vendor, however - where it sells a debt at undervalue (not at arm’s length) it is taxed as if it had sold the loan relationship at the market value.

1283.     Ghosh and Johnson’s “Taxation of Loan Relationships and Derivatives”, in referring to paragraph 11(2), agrees with this interpretation. Paragraph 6.351 reads:

However, there is no market value uplift for the purpose of computing any debits arising from the acquisition of rights under a loan relationship at less than market value (para 11(2)). “Debit” here means an “expense”, ie acquisition cost.

1284.     In most instances transactions other than at arm’s length are between group companies and Schedule 28AA to ICTA will apply. Schedule 28AA has precedence as a result of paragraph 11(1A) of Schedule 9 to FA 1996 and paragraph 11(1) of Schedule 9 will not then apply.

1285.     A rewrite change has not been introduced to reflect this meaning of paragraph 11(2) because some non-HMRC specialists on loan relationship disagree with this interpretation.

Clause 445: Disapplication of section 444 where Schedule 28AA to ICTA applies

1286.     This clause provides an exception to clause 444. Where Schedule 28AA to ICTA also applies in respect of the related transaction, clause 444 does not apply. It is based on paragraph 11(1A) and (1B) of Schedule 9 to FA 1996. The clause also excludes an adjustment to exchange gains and losses from any Schedule 28AA adjustments.

Clause 446: Bringing into account adjustments made under Schedule 28AA to ICTA

1287.     This clause requires credits and debits under this Part to reflect adjustments made under Schedule 28AA of ICTA. It is based on paragraph 16(1) and (2) of Schedule 9 to FA 1996.

Clause 447: Exchange gains and losses on debtor relationships: loans disregarded under Schedule 28AA to ICTA

1288.     This and the following four clauses provide rules for exchange gains and losses on loan relationships which are not on arm’s length terms. It is based on paragraph 11A(1) to (3) of Schedule 9 to FA 1996 and paragraph 8(1) and (3) of Schedule 28AA to ICTA.

1289.     The clause leaves exchange gains and losses, or a proportion of them, out of account where, under Schedule 28AA to ICTA, the whole or part of a loan representing a debtor relationship is ignored.

Clause 448: Exchange gains and losses on debtor relationships: equity notes where holder associated with issuer

1290.     This clause applies where interest is to be treated as a distribution under section 209(2)(e)(vii) of ICTA. It is based on paragraph 11A(1) of Schedule 9 to FA 1996. Exchange gains and losses on the security giving rise to that interest are left out of account in computing gains under this Part in respect of the debtor company.

Clause 449: Exchange gains and losses on creditor relationships: no corresponding debtor relationship

1291.     This clause applies where a company is in a creditor relationship and the transaction giving rise to the loan would not have been made on arm’s length terms. It is based on paragraph 11A(4) and (5) of Schedule 9 to FA 1996. The clause leaves exchange gains and losses out of account where there is no corresponding debtor relationship (explained in clause 450).

Clause 450: Meaning of “corresponding debtor relationship”

1292.     This clause provides the meaning of “corresponding debtor relationship” for the purposes of clause 449. It is based on paragraph 11A(4) of Schedule 9 to FA 1996.

1293.     Part 2(6) of Schedule 11 to F(No 2)A 2005 repeals the words “or would apart from section 84A(2) to (10) of this Act” in paragraph 11A(4)(c) of Schedule 9 to FA 1996 (rewritten in subsection (6)) with effect from a day to be appointed. This subsection will therefore cease to have effect from an appointed day (see Part 8 (loan relationships) of Schedule 2 to the Bill).

Clause 451: Exception to section 449 where loan exceeds arm’s length amount

1294.     Where a loan would, on arm’s length terms, have been of an amount more than nil but less than the full amount this clause takes into account a suitable proportion of the exchange gains and losses for the purposes of this Part. It is based on paragraph 11A(5) and (6) of Schedule 9 to FA 1996.

Clause 452: Exchange gains and losses where loan not on arm’s length terms

1295.     This clause provides that, where a guarantor company is connected to the creditor company, a claim under paragraph 6D of Schedule 28AA to ICTA is assumed to apply to exchange gains and losses as well as interest. It is based on paragraph 11A(7) to (10) of Schedule 9 to FA 1996.

1296.     Paragraph 6D of Schedule 28AA to ICTA applies where a company has an interest payment reduced by the transfer pricing rules of that Schedule and the loan on which that interest is paid is guaranteed by another company. The guarantor company may make a claim to be treated as if it had itself paid the interest. The guarantor company then obtains the deduction that was disallowed to the paying company. This is called a “compensating adjustment”. The interest is allowed to the extent that an independent lender would take the guarantee into account in determining the borrower’s debt capacity.

Clause 453: Connected parties deriving benefit from creditor relationships

1297.     This clause provides that if a company receives less than a commercial return under a loan relationship and, in consequence, a connected company derives benefit as a result of that relationship, credits representing that benefit are brought into account in computing the creditor company’s gains. It is based on section 93C of FA 1996. This counters an avoidance device whereby a company arranges for the equivalent value of interest that would otherwise be received to be passed by the borrower to a connected company which is not a party to the relationship.

Clause 454: Application of fair value accounting: reset bonds etc

1298.     This clause provides rules for debits and credits on loan relationships represented by bonds on which the terms change after issue, to be determined on the basis of fair value accounting. It is based on section 88A of FA 1996.

1299.     Principally, this clause counters avoidance where companies subscribe for reset bonds which increase in value after issue and are transferred to another group company at cost under clause 340 onwards. That company is then sold outside the group at market value with the profit on the bond reflected in the capital gain on the sale of the subsidiary and not as a credit under this Part.

Clause 455: Disposals for consideration not fully recognised by accounting practice

1300.     This clause provides that rights disposed of under a creditor relationship are to be brought into account where the disposal is not wholly recognised in the accounts and there is an intention to avoid tax. It is based on paragraph 11B of Schedule 9 to FA 1996.

Chapter 16: Non-trading deficits

Overview

1301.     This Chapter provides the rules for deficits on loan relationships which are not used for the company’s trade.

Clause 456: Introduction to Chapter

1302.     This clause provides a general introduction to the Chapter. It is based on section 83(1) of, and paragraph 5 of Schedule 8 to, FA 1996.

Clause 457: Basic rule for deficits: carry forward to accounting periods after deficit period

1303.     This clause provides that deficits which are neither surrendered as group relief nor set-off against profits of the loss period or earlier periods are carried forward and set against against the non-trading profits of the following accounting period. It is based on section 83(3A) of, and paragraph 4(1) to (3) and (6) of Schedule 8 to, FA 1996.

Clause 458: Claim to carry forward deficit to later accounting periods

1304.     This clause allows a company to make a claim to carry forward the deficit from the period in which it arose without the need to set it against non-trading profits under clause 457. It is based on paragraph 4(3) to (5) of Schedule 9 to FA 1996.

1305.     The deficit is then treated as if it arose in the “first later period” and falls to be carried forward to the subsequent period (ie it cannot be set against total profits of that first later accounting period). This rule also applies where no claim is made but the deficit cannot be set against non-trading profits of the first subsequent period.

 
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Prepared: 5 December 2008