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The fair value of the Company B shares for the purposes of the Company A accounts are, therefore, as
follows:
Consequently, S486B(8) makes it clear that the amounts to be brought into account under the disguised
interest rules would be as follows:
£8.75m (credit)
Year ended 31 December 2011
Meaning of arrangement
An arrangement, for the purposes of the disguised interest principle as set out in CTA09/486B(1), is
defined at CTA09/486B(9) as including:
‘…any agreement, understanding, scheme, transaction or series of transactions (whether or not legally
enforceable).’
This is a wide-ranging definition that is intended to capture any type of arrangement under which
disguised interest type returns could be obtained.
There is a specific exclusion for arrangements that constitute a finance lease for the purposes of
CAA01/S219. 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 CAA01/S70G are
not brought within the scope of the legislation). Operating leases, by contrast, are not within the scope
of the legislation at all.
Returns brought into account for other tax purposes
Without any rule to the contrary, it would be possible for the disguised interest rules to result in double
taxation. This could occur where a return economically equivalent to interest is obtained from an
arrangement and the return is already brought into charge for tax purposes.
In order to remove the possibility for double taxation, CTA09/S486C(1) provides that Chapter 2A does
not apply if and to the extent that the return is taxed as income or brought into account as income for tax
purposes apart from the Chapter.
HMRC’s view is that the exclusion in section 486C(1) applies only where what would be taxed apart
from the Chapter is, or includes, the return with which the Chapter itself is concerned. For instance, the
return on a loan relationship or the return that a financial trader earns from acquiring fixed future cash
flows or the interest-like return that a financial trader obtains from a combination of financial
instruments that together function as a loan. In each of these cases all the return is taxed as income apart
from Chapter 2A so Chapter 2A is disapplied.
By contrast the exclusion does not apply where the return comprises a combination of a loss and a profit
on two separate items where one is taxed/relieved as income and the other is a tax nothing or a capital
matter. In any such case, no part of the return would be brought into account as income apart from
Chapter 2A.
Example
Hedge Ltd acquires shares against a long total return swap. Apart from Chapter 2A Hedge Ltd would be
taxed on an income basis in respect of the total return swap but would not be charged on an income
basis in respect of the shares. However, the combination of the shares and swap will produce disguised
interest.
Section 486C(1)(a) to (c) do not apply because if the value of the shares drops, the profit on the swap
that would be taxed or brought into account as income is not (to any extent) the return. If the value of
the shares increases, the loss on the swap that would be taxed or brought into account as income is
similarly not (to any extent) the return. It follows that Chapter 2A can apply (subject to the unallowable
test).
In these circumstances, if Chapter 2A does apply, then section 486B(7) (see CFM42090) will prevent
any further charge from arising. For instance, in a case where the return includes a loss on a derivative,
then under section 486B(7) that loss will not be eligible to relief under the derivate contract rules since
it is taken into account in calculating the return.
Meaning of tax avoidance purpose
Even though the disguised interest rules set out a number of conditions that must be met in order for the
rules to apply, it is still possible that the rules could catch perfectly acceptable, commercial-driven
transactions that have no tax avoidance motive.
CTA09/S486D contains a very important feature of the disguised interest rules. This provides that the
disguised interest rules do not apply…
‘…unless it is reasonable to assume that the main purpose, or one of the main purposes, of the company
being a party to the arrangement is to obtain a relevant tax advantage.’
This means that unless the purpose (or one of the main purposes) of the arrangements is to obtain a
‘relevant tax advantage’, then the disguised interest rules cannot apply. Consequently, the disguised
interest rules should not inadvertently catch commercially-driven transactions with no purpose of
obtaining a ‘relevant tax advantage’ that just happen to fall within the specific conditions for the
disguised interest rules to apply.
‘To obtain a relevant tax advantage’ is defined in S486D(4) as meaning to secure that the return is
produced in such a way that means 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 the disguised interest rules.
This purpose test requires consideration of two questions:
• Whether, as a matter of fact, the return produced by the arrangements for the company is produced in a form
(e.g. 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.
• 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 rise to that advantage.
S486D(5) makes it clear that the tax avoidance exclusion does not apply where the return is produced
for a company that is a controlled foreign company (CFC).
Where a question of purpose arises the matter should be referred to Anti-Avoidance Group.
Election
It is possible that some companies may enter into arrangements that were specifically structured so that
they fall within the disguised interest rules. This would allow the tax treatment of the value of the shares
to be brought into line with their amortised cost-based accounting treatment or, possibly, to achieve a
post tax hedge.
These arrangements would not fall within the disguised interest rules because they will not have a tax
avoidance motive. Consequently, companies have the option of electing out of the tax avoidance
purpose test so that they are within the disguised interest rules regardless of their motive of entering into
the arrangements.
The election cannot be made by a company where the disguised interest rules apply due to S486B(6)
(CFM42080).
The election must be made no later than the time when the arrangement begins to produce a return for
the company and any election, once made, is irrevocable.
Excluded shares
The disguised interest rules will not apply where the arrangement involves an investment in shares and
the share is ‘excluded’ by CTA09/S486E.
The intention behind the excluded share rules is that it will prevent arrangements being caught by the
disguised interest rules where the interest-like return arises to a company purely as a result of an
increase in the value of any share that it holds in a group company.
Without this rule, it would be possible for a single interest-like return to be taxed repeatedly within a
chain of companies in the same group.
Example
Company A holds 100% of the share capital in Company B. Company B holds 100% of the share
capital in Company C and has no other assets. All companies are UK resident.
In the year ended 31 December 2009 Company C has no assets other than a £100m deposit with a bank
at an interest rate of 5% p.a.
Company C receives £5m interest in the year ended 31 December 2009 and that income is relieved by
non-trading debits on loan relationships brought forward. The fair value of the shares held by Company
B in Company C will also increase by £5m as compared to a previous fair value of £5m. This would be
a ‘return economically equivalent to interest’ and potentially could fall within the disguised interest
rules. Similarly, the increase in the fair value of Company B’s shareholding in Company C will cause a
similar increase in the fair value of Company A’s shareholding in Company B. Consequently, Company
A will have a return on its shares in Company B that would potentially be within the disguised interest
rules.
The impact of this chain is that both Company A and Company B could potentially be taxed on a return
that has already been brought into account by Company C.
The ‘excluded share’ rules will prevent the same economic gain from being taxed repeatedly within
group situations. In the above example it would mean that Company B’s holding would be excluded if
the return Company B obtains is an increase in value of the Company C shares. Company A’s holding is
excluded if its return is an increase in the value of the Company B shares.
It achieves this by ensuring that:
• investments in shares in connected companies are automatically ‘excluded shares’;
• investments in shares in joint venture companies are automatically ‘excluded shares’;
• investments in shares in a ‘relevant CFC’ are automatically ‘excluded shares’
CFM42130 to CFM42160 looks at the rules in greater depth.
Excluded shares: the basic rules
CTA09/486E(1) sets out the basic rule that the disguised interest rules will not apply in any ‘relevant
accounting period’ where the return ‘involves only’ ‘relevant shares’.
Relevant accounting period
CTA09/486E(2) defines ‘relevant accounting period’ as:
• beginning when the holding company becomes party to the arrangement or, if later, when the arrangement
begins to produce a return to the company;
• ending when the holding company ceases to be party to the arrangement or, if earlier, the end of the relevant
accounting period.
See CFM42160 for more in the meaning of ‘involves only’, and CFM42170 for more on ‘relevant
shares’.
Meaning of ‘involves only’
CTA09/486E(3) sets out that, for the purposes of S486E an arrangement ‘involves only’ relevant shares
if (and only if) the return produced reflects only an increase in the fair value of the shares.
This definition of ‘involves only’ is important as it prevents any returns from arrangements, other than
those arrangements that the excluded shares exemption is intended to prevent from being within the
disguised interest rules, from being taxed within the disguised interest rules.
In this context, ‘only’ should be interpreted strictly although legislation makes clear that the payment of
a dividend will not affect the question of whether the requirement is met. Similarly, if the shares are
sold for their fair value, the return has already been produced so the disposal itself does not prevent the
return reflecting only the increase in the fair value of the share.
The fair value of shares is the amount that a company would obtain from a knowledgeable and willing
purchaser of the shares dealing at arms length (CTA09/486E(4)).
Relevant shares
CTA09/S486E(5) defines ‘relevant shares’ as:
1. Fully paid-up shares of a ‘relevant company’ (see CFM42180)
2. Shares, other than shares in a ‘relevant company’ that fall within the rules for ‘shares accounted for as
liabilities’ at CTA09/PT6/CH6A (CFM45500). Briefly, such shares are those:
○ that would be accounted for in accordance with GAAP as a liability by the company in which they are
shares, and
○ which produce for the company holding the shares a return in relation to any amount which is
economically equivalent to interest.
CTA09/S486E(7) provides that a company is a relevant company if:
• it and the holding company are connected companies
• it is a relevant joint venture company or
• it a relevant controlled foreign company