CFM35985 – Corporate Finance Manual – HMRC Internal Manual

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FA15/S25

What changes have been made?

FA15/S25 limited the categories of connection to which the default interest rules apply. It also brought a similar limitation to heavily reduced security rules at CTA09/S406-S412.

The rules on late interest paid and heavily discounted collateral were originally introduced to address tax asymmetries between the lender and the borrower of a loan. However, these provisions have been deliberately exploited by some businesses to increase the amount of tax relief they can get for interest charges.

The original connection categories were:

The first and third bullet points have now been removed. Accordingly, the connection categories are limited to:

  • Connection by participation in a close company: S375
  • Attachment via a pension scheme: S378

Beginning and transition

New loans

The changes apply to loans entered into on or after December 3, 2014.

The default interest limitation rule will therefore not apply to debtors of interest on a loan relationship if the link between the debtor and the creditor was only through the link by control (S374) and the link by major interest (S377). Late payment interest rules will continue to apply if either of the other two categories is satisfied.

Existing loans

In cases where a loan was taken out by a business before December 3, 2014, the existing rules continue for interest accrued no later than December 31, 2015.

If interest had been disallowed based on S374 or S377, all interest accrued in subsequent periods will be deductible as it accrues, rather than when it is paid.

For these purposes, where a company has an accounting period that straddles January 1, 2016, it will be treated as having two notional accounting periods, the first ending on December 1, 2015 and the second beginning on January 1, 2016.

Therefore, charges accumulated during the first notional period will be denied, but charges accumulated during the second notional period will be authorized.

Modified Loans

However, the extended treatment does not apply where there has been a material change in the terms of the relationship, or if there is a change in the person holding the position of creditor. This would be the case in particular when:

  • The amount lent under the loan is significantly increased.
  • The duration of the loan is considerably extended.
  • The loan receivable is transferred to a tax haven.

In such cases, changes to late payment interest rules will apply from the date of the change.

For these purposes, a notional accounting period must have ended immediately before the change, and a new notional accounting period beginning on the day of the change.

Previously accrued interest

Where interest has already been disallowed under the default interest rules, the effect of S373 continues to apply in respect of interest. Accordingly, relief from such interest will be available at the time it is paid (subject to other legal provisions).

Examples

Example 1:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is a UK resident company.

A Ltd loaned B Ltd £1,000,000 on June 10, 2014 at 2.5% interest per annum. B Ltd includes interest expense for the accounting periods ended December 31, 2014 and December 31, 2015, and as of December 31, 2016 accrued interest remains unpaid.

The interest is “late” and has not been accounted for by A Ltd. Conditions A and B of S373/CTA09 are therefore fulfilled.

The default interest rule will therefore prohibit any loan relationship debit for unpaid interest for the periods ended December 31, 2014 and December 31, 2015 based on a major interest link in S377/CTA09. Relief from this interest will be available on a paid basis.

For accounting periods from December 31, 2016, interest will be deductible as it accrues.

Example 2:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is a UK resident company.

A Ltd loaned B Ltd £1,000,000 on June 10, 2014 at 2.5% interest per annum. B Ltd includes interest expense for the accounting period July 1, 2015 to June 30, 2016, and this interest remains unpaid as of June 30, 2017.

The interest is “late” and has not been accounted for by A Ltd. Conditions A and B of CTA09/S373 are therefore fulfilled.

The company has two notional accounting periods. During the notional period ended December 31, 2015, the debit of accrued interest is not permitted. Support will be available on a paid basis.

For the period ended June 30, 2016, S377 no longer applies and interest is allowed as it accrues.

Example 3:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is resident in the United Kingdom.

A Ltd loaned B Ltd £1,000,000 on December 10, 2014 at 2.5% interest per annum. B Ltd includes interest expense in the accounting periods ended December 31, 2014 and December 31, 2015, and accrued interest remains unpaid as of December 31, 2016.

The interest is “late” and has not been accounted for by A Ltd. Conditions A and B of S373/CTA09 are therefore fulfilled.

As this debtor relationship was entered into after December 3, 2014, S377 no longer applies. There will be no restriction on the charging of interest to B Ltd under S377 and interest is permitted as it accrues.

Example 4:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is resident in the United Kingdom.

A Ltd loaned B Ltd £1,000,000 on June 10, 2014 at 2.5% interest per annum. B Ltd includes interest expense in the accounting periods ended December 31, 2014 and December 31, 2015, and accrued interest remains unpaid as of December 31, 2016.

The interest is “late” and has not been accounted for by A Ltd. Conditions A and B of S373/CTA09 are therefore fulfilled.

For the period ending 31 December 2014, CTA09/S373 applies to reject any loan relationship debit claimed by B Ltd on the grounds that A Ltd has a material interest in B Ltd under S377. Support will be available on a paid basis.

On July 1, 2015, there is a material change in the terms of the loan relationship.

For the year ended December 31, 2015, the company is treated as having two notional accounting periods. During the notional period ended June 30, 2015, the debit of accrued interest is not permitted. Support will be available on a paid basis. For the period ended December 31, 2015, S377 no longer applies and interest is allowed as it accrues.

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