CFM37850 – Corporate Finance Manual – HMRC Internal Manual

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Where an instrument meets the CTA09/S475C definition of a hybrid capital instrument, the tax rules provide for the following provisions.

Hybrid capital instruments accounted for using the equity method

CTA09/S320B provides that any amount recognized in equity or equity is recognized in the same way as if it had been an item of profit or loss. It does not apply to amounts already recognized as items of profit or loss or as items of other comprehensive income. It also does not apply to amounts of foreign exchange gains or losses recognized in specified statements.

Instruments issued in accounting periods beginning before January 1, 2016 already benefit from this treatment (see CFM33170). In addition, instruments that fell under the RCS Regulation also benefited from the same tax treatment. The new rules apply this treatment, from January 1, 2019, to hybrid capital instruments (HCI) accounted for using the equity method, regardless of their date of issue.

Where foreign exchange gains or losses arise on loan assets or derivative contracts intended to hedge foreign exchange risks on an HCI that is accounted for under the equity method, such foreign exchange gains or losses are not taken into account for tax purposes. . This is achieved by amendments to Regulations 2, 3 and 4 of the Disregard Regulations 2004 (SI2004/3256).

Normal business loans

CTA10/S162(1B) provides that HCI will constitute “normal commercial loans” for the purposes of group relief and the definition of qualifying corporate bonds in relation to capital gains.

Distributions and special titles

Right to defer or cancel interest (CTA09/S420A)

Hybrid capital can only qualify as HCI if the instrument “provides under which the debtor has the right to defer or cancel a payment of interest” during an accounting period (see CFM37840) (CTA09/ S475C(1)(a)).

The ability to defer the payment of interest on a loan relationship will generally not cause an amount payable to be considered a distribution (CFM37830).

The ability to cancel an interest payment on a loan relationship may generally result in any amount payable being treated as a distribution for the purposes of Part 23 CTA 2010. However, s420A provides that the ability to cancel the interest payable on an HCI does not, by itself, make any amount payable a distribution. S420A(3) ensures that if an instrument qualifies as an HCI, any cancellation or deferral of interest (whether mandatory or not) should not be taken into account when determining whether amounts payable under HCIs are distributions.

Example:

An instrument which gives the issuer the discretion to cancel interest at any time will be considered an HCI provided it also meets the conditions of s475C(1)(b) and (c). If that instrument also contains a provision requiring the issuer to cancel payments where the issuer has insufficient distributable reserves, both provisions will fall under paragraph s420A(3), so both provisions are disregarded in determining if the amounts payable under the hybrid capital instrument are distributions.

S420A applies for the purposes of the Corporation Tax Acts (Section 420A(2)), which according to Schedule 1 of the Interpretation Act 1978 include enactments relating to the taxation “of corporate distributions (including income tax provisions)”. It therefore affects the treatment of sums payable in the hands of the payer and the beneficiary.

Participation tickets (CTA10/S1015(1A))

A lending relationship that qualifies as an HCI may include provisions that qualify to be a capital rating for the purposes of CTA10/S1015(6). Section 1015(1A) provides that an HCI is not a special security because it meets these conditions.

Remaining distribution rules (CTA10/PART23)

However, the rest of the distribution rules apply to HCI, so their coupons are only deductible to the extent that they are not distributions. For example, if the instrument bears an excessive interest rate and is therefore a non-commercial security, as defined by CTA10/S1005, part of the payment may be interest (the reasonable commercial yield) and the rest a distribution.

Restriction of business interest

Under TIOPA10/S413(6), relevant expense amounts arising from an HCI are considered to be adjusted net group interest expense (ANGIE) for the restriction of corporate interest.

Stamp duties

The transfer of an HCI is exempt from all stamp duty (FA19/Schedule 20/para20).

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