ANNEX 1:: MINOR CHANGES IN THE LAW MADE BY THE BILL This change is in taxpayers’ favour in principle. But it is expected to have no practical effect as it is in line with current practice. Change 74: Interest relief: recovered capital: section 406
This change amends the rule in section 363 of ICTA about the effect on the amount of loan interest eligible for relief when capital is recovered from the business entity in which the proceeds of the loan were invested.
Section 363 of ICTA applies where the interest on a loan to an individual qualifies for relief under section 353 of ICTA because it meets the conditions in section 360 (loan to buy interest in close company), section 361 (loan to buy interest in co-operative or employee-controlled company) or section 362 (loan to buy into partnership) and subsequently the individual recovers capital in the circumstances set out in section 363(2), but does not use that capital in repaying that amount of the loan.
In such a case the individual is treated as if he or she had repaid the loan to the extent of the recovered capital, with the result that the interest eligible for relief is correspondingly reduced. Where only part of the loan qualified for relief, the notional repayment is set against the qualifying part.
Sections 360, 361 and 362 of ICTA each contain another provision under which relief is lost completely if the individual recovers capital that is not taken into account under section 363. (See, for example, section 362(2)(b)). It follows that if the individual has recovered capital that is in fact used to repay part of the loan, then, since section 363 does not apply, the individual loses relief completely. This result was not intended. The correct result is achieved if section 363 applies where any capital recovery within that section occurs, whether or not the recovered capital is used to repay the loan. Then the provisions like section 362(2)(b) only bite where capital is recovered in circumstances not within section 363.
Accordingly, section 363(1) of ICTA has been rewritten in section 406 without the words which restricted its application to cases where the recovered capital was not used in repayment of the loan. And so the rule providing for a corresponding reduction in the interest eligible for relief, where only part of the loan qualified for relief, has been modified to ensure that the reduction is made from the amount of interest that would be payable and eligible for relief if no repayment, whether deemed or actual, had been made.
There may be cases in practice in which relief has been given (wrongly in law) for interest paid where the amount recovered was used to repay part of the loan. To the extent that the recovery has been set against the qualifying part of the loan then this change legislates that practice, which is generally in taxpayers’ favour.