Introduction Disguised Interest
2.Paragraph 1 amends Part 6 of the Corporation Tax Act 2009 (CTA), which deals with certain matters that are treated as loan relationships, although they are not actually loan relationships. All references below are to the CTA unless otherwise indicated.
3.Paragraph 2 inserts into CTA a reference to the new Chapter 2A which contains the legislation on disguised interest.
4.Paragraph 3 inserts the new Chapter 2A into CTA. References to Chapter 2A below are to the new Chapter 2A.
5.Section 486A is introductory. It provides for Part 5 of CTA (loan relationships) to apply in relation to returns which are economically equivalent to interest. It also refers to exceptions in section 486C to 486E (see notes on the exceptions below).
6.Section 486B(1) contains the legislative principle. Where a company is party to an arrangement that produces for it a return on an amount which is “economically equivalent to interest” then the return is to be taxed as if it were a profit from a loan relationship.
7.Section 486B(2) defines what is meant by a return on an amount that is “economically equivalent to interest”.
8.Section 486B(2)(a) reproduces a number of indicia commonly cited in cases on the meaning of interest:
9.The return must be calculated by reference to an amount. In Euro Hotel (Belgravia) Ltd 51TC293 Megarry J said:
	“there must be a sum of money by reference to which the payment which is said to be interest is to be ascertained”. Thus, the return has to arise from some form of investment or entitlement; and
	it must be reasonable to assume that it is a return by reference to the time value of that amount. In Bennett v. Ogston 15 TC 374 Rowlatt J described interest as 'payment by time for the use of money'.
10.Section 486B(2)(b) provides that the rate of return must be reasonably comparable to a commercial rate of interest.
11.Section 486B(2)(c) ensures that, viewed at the “relevant time”, there must be no “practical likelihood” that the arrangement will cease to produce the return (unless the person by whom it falls to be produced is prevented from producing it). “Practical likelihood” is the term used by Lord Oliver in Craven v White 62 TC 1 commenting on Lord Brightman’s speech in Furniss v Dawson 55 TC 324 describing the cases when the Ramsay principle, as understood at the time, would apply. It has now to be understood in the light of the judgment of the House of Lords in Scottish Provident Institution 76 TC 538 as precluding attempts to manufacture a “falsifying” arrangement.
12.Section 486B(3) defines the relevant time as the later of the time when the company becomes party to the arrangements or the time when the return begins to be produced.
13.It must therefore be clear at the outset that the return will be produced. Thus, although there is no express requirement for the arrangement to be “designed” to produce the return, the return must be initially predictable.
14.Subsections (4) and (5) ensure that the credits and debits in respect of the loan relationship are taxed on an amortised cost basis; this being regardless of whether they are recognised in the accounts of the company that obtains the return. Thus, if the return is capitalised by being included in the value of an asset on the balance sheet, or is not recognised, in the accounts at all, the return must still be recognised using an amortised cost basis so that the whole of the return is recognised on an accruals basis.
15.Section 486B(6) deals with cases where two or more persons are party to an arrangement which in aggregate produces a return to which the legislation would apply if it were produced for just one of them. The taxable return is apportioned between them on a just and reasonable basis.
16.This rule is intended to prevent companies side-stepping the new rule by fragmenting the return so that each return looked at separately does not constitute an interest-like return, but when the return is looked at as a whole it does.
17.Section 486B(7) provides that the only amounts brought into account for corporation tax purposes in relation to a return are those that are brought into account under section 486B. This for instance ensures that any return that is so brought into account is excluded from corporation tax on chargeable gains. See also the comments on section 486C below, which indicate how this provision interacts with that section.
18.Section 486B(8) ensures that the credits and debits to be brought into account include exchange gains and losses that arise as a result of translating the accounts carrying value of the return and the principal amount by reference to which the return falls to be produced.
19.Section 486B(9) defines arrangement as including any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable). It does now however include any arrangement that constitutes a finance lease within the meaning of section 219 of the Capital Allowance Act 2001 (CAA). This ensures that all such arrangements continue to be taxed according to current rules (and in particular that leases that are not long funding leases within the meaning of section 70G of CAA are not brought within the scope of the legislation). Operating leases by contrast are not within the scope of the legislation at all.
20.Section 486C is a scope or boundary rule: it provides that any part of the return that is charged to corporation tax as income of the company or brought into account as income of the company for corporation tax purposes is not charged under the Chapter. The exclusion does not apply where the return would fall to be taxed as income or brought into account as income at any time that is later than the time when it would be taxed under section 486B, meaning that (if the section applies at all) it is not disapplied in relation to income that would be taxed at a time later than under section 486B. But if in consequence Chapter 2A has the effect that some of the income is taxed before it otherwise would be, section 486B(7) then ensures that that income is not taxed again.
21.Section 486C also provides that any exclusion in relation to debits or credits arising from items within the loan relationship, derivative contracts or intangible fixed asset rules is not overridden by anything in Chapter 2A. However, this does not apply in relation to any return that would be taxed as a chargeable gain by virtue of section 641 (which treats profits on certain types of derivative contracts as capital ones).
22.Section 486D(1) provides an important exclusion for any case where it is not the main purpose or one of the main purposes (if there is more than one) of the company being party to the arrangement to obtain a “relevant tax advantage”. “Relevant tax advantage” is defined in section 486D(4).
23.Section 486D(2) provides that a company may elect that the Chapter is to apply in relation to a particular arrangement as if section 486D(1) were omitted. Such an election might be advantageous to the “lender” under an arrangement such as a structured finance arrangement who, at least in theory, may otherwise be taxed on a greater amount than under the disguised interest rules.
24.Section 486D(3) provides that an election may not be made by a company in a case where the Chapter applies by virtue of section 486B(6). It also provides that the election must be made no later than the time when the arrangement begins to produce a return for the company, and is irrevocable. This is subject to paragraph 15 of the Schedule, which in all cases allows an election to be made before 1 August 2009, having effect in relation to returns produced on or after the time the election is made.
25.Section 486D(4) provides that “to obtain a relevant tax advantage” means to secure that the return is produced in a way that means that it would be taxed more favourably than it would be if it were charged to tax as income or brought into account as income at the time that the return would be recognised under section 486B.
26.This main purpose test requires consideration of two questions. The first question is whether, as a matter of fact, the return produced by the arrangements for the company is produced in form (such as a capital gain or dividend) that would be taxed more favourably than it would be if that return were taxed in the same way as interest. This is a purely objective matter. The second question is whether it is reasonable to assume that it was a main purpose of the company being party to the arrangements to secure that the return was produced for it so as to give that rise to that advantage.
27.Section 486D(5) provides that the tax avoidance exclusion does not apply where the return is produced for a company that is a controlled foreign company (CFC). This is because it is unclear whether a company that is not within the charge to corporation tax can have a main purpose of avoiding it.
28.For this purpose, a CFC means a company whose profits are apportioned or would be apportioned but for one of the exemptions in section 748(1) of the Income and Corporation Taxes Act 1988 (ICTA).
29.Section 486E introduces the other main exclusion from Chapter 2A and the notion of “excluded shares”.
30.Section 486E(1) states that the Chapter will not apply for an accounting period (the “relevant accounting period”) for which an arrangement produces a return if the arrangement involves only “relevant shares” held by the company (“holding company”) for which the return is produced throughout the “relevant period”.
31.Section 486E(2) to (11) contain definitions relevant for construing section 486E(1).
32.Section 486E(2) explains what is meant by “relevant period”. It is the period starting with the date on which the company becomes party to the arrangement (or if later when the return begins to be produced) and ending with the end of the accounting period for which it is necessary to ascertain whether the share is a relevant share (or if earlier when company ceases to be party to the arrangement or when the arrangement ceases to produce a return).
33.Section 486E(3) explains what is meant by “involves only” a share. An arrangement involves only a share if (and only if) the return that is produced for the company consists purely of an increase in the fair value of the share. This thus excludes from Chapter 2A all straightforward share investments in “relevant shares” where the only economic exposure that the holding company has to the shares that it holds is to the value of the shares. The legislation also clarifies that where part of a fair value increase is paid as a dividend then that is not to affect the question of whether a return reflects only such an increase.
34.It follows that the legislation is not prevented from applying where the return is derived from a combination of holding the share and some other arrangement such as a forward sale or other derivative. It also follows that it would not be prevented from applying if the arrangement involves some other transaction such as a repo (and see in this connection section 486E(11)). But in any such case it would still be necessary for a tax avoidance purpose (within section 486D) to be present before the legislation could apply.
35.Section 486E(4) defines “fair value” in the same way that it is now defined for loan relationship purposes (see section 313(6) of CTA). It also clarifies that payment of a dividend does not affect the fair value return arising from a share.
36.Section 486E(5) defines “relevant shares” as meaning shares which throughout the “relevant period” are either i) “fully paid up shares” of a “relevant company” or ii) other shares which would be accounted for by the issuer as a financial liability and which produce for the holding company a return economically equivalent to interest for the purposes of Chapter 6A (shares as liabilities). It is not necessary for there to be any charge under Chapter 6A in relation to such a share in order for this exclusion to apply. Section 930I (corporation tax treatment of company distributions)_also ensures that such shares do not generally give rise to taxable distributions (subject to section 930M).
37.Section 486E(6) defines “fully paid-up share” for the purposes of subsection (1), in terms similar to section 524(4) of CTA. This requirement is meant to ensure that arrangements such as those within section 524 of CTA will continue to be caught.
38.Section 486E(7) defines “relevant company”. A relevant company is a company connected with the holding company, a relevant joint venture company, or a relevant CFC.
39.Section 486E(8) defines “connected” for the purposes of subsection (7) as having its section 466 of CTA meaning. This is equivalent to old section 87 of the Finance Act (FA) 1996.
40.Section 486E(9) defines “relevant joint venture company” as a company in relation to which the holding company has at least a 40 per cent interest provided that one other person also has such an interest.
41.Section 486E(10) provides that section 755D of ICTA is to have effect for the purposes of determining “control” in subsection (9).
42.Section 486E(11) defines a relevant CFC as one whose profits are apportioned to the holding company or are not so apportioned because of an exemption.
43.These exclusions are intended to put beyond doubt that straightforward share investments in relevant companies cannot give rise to a charge at any tier. This is because the only return that arises at each tier is an increase in the value of the relevant shareholding in a group company. So if company A holds all shares in company B which holds all shares in company C, then company B’s holding is excluded if the return company B obtains is an increase in value of the company C shares and company A’s holding is excluded if its return is an increase in value of the company B shares.
44.Section 486E(12) provides that section 550(3) shall not have effect for the purpose of determining whether shares are held by a company for the purposes of this section (excluded shares). Section 550(3) deems a company to hold shares when as a matter of fact it does not, so this provision ensures that the section 486E exclusions, which depend upon a company holding a share, cannot be engaged by this deeming. On the other hand there is nothing to prevent section 545(2), which deems a company that holds shares under a creditor repo not to hold them, from applying. This means that the exclusions in section 486E do not apply to either the original owner or temporary owner under a repo.