Commentary on Sections Overview Overview Section 444: Transactions not at arm’s length: general
1281.This and the following seven sections 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 section 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 section 445).
1282.Paragraph 11(2) refers to debits arising from the acquisition of rights under a loan relationship. The 1996 notes on sections 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.
1283.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.
1284.Paragraph 6204 of the Corporate Finance Manual reads:
FA96/SCH9/PARA11(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.
1285.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.
1286.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.
1287.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.