Disguised Interest reform by abstraks


									                                                                              10 October 2008

‘Disguised Interest’ reform
                                   HMRC Issues Revised Draft Legislation

For more information please        HMRC have issued, to a limited audience, revised draft legislation and
speak to your usual Deloitte       guidance notes on the proposals to introduce a ‘principles-based’
contact or any of the following:   approach to the taxation of ‘disguised interest’. The new proposals
                                   were discussed at a recent meeting.

                                   As a reminder, HMRC launched a consultation process in December
                                   2007 proposing a new principles-based approach, which is designed to
Stephen Weston                     secure that an investment return economically equivalent to interest is
Tel: 020 7007 4568                 taxed in the same way as interest. The proposals seek to tax such a
Email: sgweston@deloitte.co.uk     return as a credit under the loan relationships regime, even though
                                   the underlying items are not loan relationships. There will be a just and
                                   reasonable apportionment where more than one company is party to
Ben Moseley                        an arrangement.
Tel: 0161 455 8577
Email: bmoseley@deloitte.co.uk     HMRC have recognised the concerns and comments raised during the
                                   consultation process, and the previously wide scope of the proposals
                                   has been narrowed considerably. The ‘principle’ underlying the original
                                   proposals was not understood or agreed and potentially had a very
David Boneham                      wide scope.
Tel: 020 7007 0038
Email: dboneham@deloitte.co.uk     HMRC’s new proposals are much more targeted anti-avoidance, albeit
                                   worded broadly in an attempt to make it difficult for structured finance
                                   planning to sidestep detailed rules. As a result, the latest proposals
                                   appear to be more workable, although perhaps rather less ‘principles-
                                   based’. It is understood that a number of concerns about detailed
                                   aspects were raised at the discussion meeting and, should the Treasury
                                   decide to go ahead, it is hoped that further changes will be made.

                                   The key points can be summarised as follows:

                                   Tax advantage test
                                   The draft legislation now contains a motive test, such that the rules will
                                   not apply unless the main purpose, or one of the main purposes, of the
                                   arrangement is that the return is not brought into account for
                                   corporation tax purposes.

                                   This should ensure that most non tax-motivated transactions are
                                   excluded from the scope of the rules. HMRC have chosen to take this
                                   route rather than introducing a wide range of specific identified

                                   Excluded shares
                                   In addition to the motive test, there are some specific exclusions from
                                   the rules; for instance shareholdings in controlled foreign companies
                                   ("CFCs"), companies that would be CFCs but for satisfying an
                                   exemption, group trading companies and certain group investment

                                   These exclusions should cover many of the situations where concerns
                                   have been raised about potential double taxation. However, the
                                   exclusions are tightly drafted (in particular, applying where the
                                   arrangement involves only a shareholding in the entity concerned), so
                                   it is not certain that all instances of double taxation will be covered.

                                   Whilst CFCs that meet one of the exemptions, or where profits are
                                   apportioned, are excluded, the draft does not exclude companies which
                                   are not subject to a lower level of tax. In addition, the proposals would
                                   apply to determine the profits of CFCs – thereby disqualifying some
                                   from exemption. There is still some concern that the proposal is not
                                   completely linked to the separate discussions on Foreign Profits.
'Redeemable' shares
Under a principles-based approach, many redeemable preference shares (and other shares where it is
expected that the investor will realise an interest-like return and effectively recover the initial investment)
could be caught due to their nature; however, there would be no corresponding provisions to provide relief for
the associated expense.

HMRC have therefore decided to exclude such 'redeemable' shares from the proposed legislation. These will
instead be covered by an amended form of the existing legislation at FA 1996 s.91D – which will be included in
the new Corporation Tax Act 2009 (the first instalment of the Tax Law rewrite in the corporation tax area).

Foreign currency transactions
The draft legislation includes a clause to disallow foreign exchange losses. HMRC's draft guidance states that,
where a return is denominated in a low interest rate foreign currency, exchange gains which bring this return
up to a sterling rate will be taxable; whereas if the return is in a high yield currency, foreign exchange losses
will not be deductible. This suggests a one-sided approach, and HMRC's guidance on this provision generally is
confusing in that it assumes that foreign exchange differences will ‘adjust’ a non-sterling return to a sterling
rate, which economic theory may dictate, but economic reality will not necessarily secure.

Of course, non-sterling returns could only fall within the scope of the rules if the tax advantage test mentioned
above were to be satisfied. Further work is needed in this area.

Exclusivity of other regimes
HMRC have confirmed in their guidance on these proposals, and in the recent workshops, that they expect the
exclusivity provisions contained in the loan relationships, derivatives, and intangibles codes to prevail over the
disguised interest regime. For example, any returns on a loan relationship should not be capable of being
taxed under these proposals.

Brought forward losses
The February 2008 draft legislation indicated that arrangements involving the introduction of income-
producing assets into a company with brought forward non-trade deficits, in order to use these attributes,
could be caught by the legislation. This was strongly resisted during the consultation process; HMRC have
dropped this explicit proposal and accept that using economic losses is not tax avoidance.

The draft legislation is proposed to take effect in relation to arrangements entered into on or after 1 April
2009; therefore existing arrangements, and transactions taking place before this date, should not be affected.
Sections 91A-E, FA 1996 (excluding 91D) will be repealed in respect of new transactions. This approach is

There are expected to be grandfathering provisions for shareholdings currently taxed under FA 1996 Section
91A-E (excluding 91D), although these are not contained in the draft clauses circulated. The proposals on
transfers of income streams are now part of a separate consultation process.

Next Steps
The Treasury has yet to decide whether or not to recommend the proposals to Minsters. Should Ministers
decide to go ahead, it is expected that a public consultation will be launched, possibly at the Pre Budget
Report 2008. In our view, the latest proposals do look more workable and it is possible that legislation will be
enacted in some form as part of Finance Act 2009.

Groups should therefore consider the potential impact on future and/or existing transactions. Your usual
Deloitte contact, or one of the contacts listed at the front of this bulletin, would be happy to discuss the
proposals in more detail.

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application of the principles set out will depend upon the particular circumstances involved and we recommend that you
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