Budget Notes

BN21 FINANCIAL PRODUCTS AVOIDANCE: DISGUISED INTEREST AND TRANSFERRING RIGHTS TO LEASE RENTALS

Who is likely to be affected?

1. Large companies who enter into arrangements to avoid tax on returns from investments that are economically equivalent to interest.

2. Companies leasing plant or machinery that sell the right to lease rental income.

General description of the measure

3. These measures address a number of avoidance schemes that have been notified to HM Revenue & Customs under the disclosure rules introduced in Finance Act (FA) 2004. Most involve arrangements that give rise to amounts that in substance are interest but which are designed not to be taxable as interest ("disguised interest"). One involves an arrangement which aims to exploit existing legislation on disguised interest so as to generate artificial losses.

4. Work will continue to develop a "principles-based", or generic, approach to ensuring that all such arrangements are taxed in the same way as interest, with the intention of legislating in Finance Bill 2009. However, in order to tackle immediate avoidance, legislation will be introduced in Finance Bill 2008 to block the following schemes:

(a) Arrangements to avoid corporation tax by receiving interest in the form of non-taxable distributions;

(b) Arrangements as a result of which the charge to tax on interest is reduced or eliminated by credits for overseas tax in circumstances where no such tax is ever suffered;

(c) Avoidance of corporation tax by the adoption of differing accounting treatments within a group for convertible debt;

(d) Arrangements where companies acquire partnership rights in advance for an amount equal to the discounted value of the rights so as to generate disguised interest;

(e) Arrangements (previously dealt with by section 131 of FA 2004) where companies that are members of partnerships obtain disguised interest on partnership contributions by altering profitsharing ratios;

(f) Schemes where attempts are made to exclude from the derivative contracts legislation transactions that are designed to produce disguised interest.

Legislation will also be introduced to stop schemes that are intended to avoid or exploit the 2005 "shares as debt" rules in sections 91A and 91B of FA 1996 by means of:

(g) Depreciatory transactions intended to create artificial losses;

(h) Rates of interest said to be "uncommercial";

(i) Spreading disguised interest between two or more companies;

(j) "Falsifying transactions" that without affecting the overall return are said to prevent the legislation from applying;

(k) Use of exit strategies that do not amount to exit arrangements for the purpose of the shares as debt rules.

5. In addition, the measure will counter notified schemes that are intended to allow lessors of plant or machinery to dispose of the right to taxable income in exchange for a tax-free sum. The changes will ensure that where the right to receive rentals is transferred the value receivable will be taxed as income.

Operative date

6. The changes have effect in relation to the countermeasures on disguised interest:

•    for schemes (a), (b) and (f), credits that relate to any time on or after 12 March 2008;

•    for scheme (c) credits and debits that relate to any time on or after 12 March 2008;

•    for schemes (d) and (e), returns that relate to any time on or after 12 March 2008;

•    for scheme (g) debits that relate to any time on or after 12 March 2008;

•    for schemes (h) to (k) shares held on 12 March 2008, but so that no amounts are brought into account unless they relate to times on or after 12 March 2008;.

7. Where the right to receive rentals under a lease of plant or machinery is transferred, the measure will have effect where the arrangements to transfer are entered into on or after 12 March 2008.

Current law and proposed revisions

Disguised interest

8. In outline, the proposed changes will block the schemes as follows:

(a) a company that receives interest which is treated for tax purposes as a distribution will be taxable on the distribution if it arises in connection with tax avoidance;

(b) the entitlement to the tax credit under section 807A(3) of the Income and Corporation Taxes Act 1988 (ICTA) will be removed by its repeal;

(c) where tax asymmetry arises because different accounting treatment is adopted by holder and issuer in relation to intra-group convertible debt, then the holder will be required to bring into account additional credits to match the issuer's debits;

(d) and e) where the relevant conditions are met a company deriving disguised interest from an interest in a partnership will be charged to corporation tax on that return;

(f) the derivative contract rules will be amended to ensure that where derivative contracts whose underlying subject matter is shares are designed to produce disguised interest, then that return will be charged to tax under the derivative contract rules.

The shares as debt rules (sections 91A to 91G of FA 1996) will be amended so that:

(g) no debits of any kind may be brought into account in respect of shares to which those rules apply;

(h) the special tax definition of commercial rate of interest is repealed;

(i) the rules can apply where the disguised interest is spread between two or more companies;

(j) falsifying transactions are ignored in a wider range of circumstances than currently;

(k) exit arrangements include any case where it is reasonable to assume that the investing company will become entitled to receive amounts equivalent to redemption proceeds.

Leases of plant or machinery

9. Section 785A Income and Corporation Taxes Acts 1988 is intended to ensure that a person is taxed on the consideration received when the right to receive rental under a lease of plant or machinery is transferred to another person. Arrangements have been entered into that attempt to avoid that section by arranging for the transfer to take place -

•    for value that is claimed not to amount to consideration received;

•    in such a way that it is not 'to another person';

•    shortly before the lessor migrates from the UK and before the consideration is received.

10. Changes will be made to ensure that section 785A applies:

•    where the right to rental is transferred for a value that may not amount to consideration;

•    where the transferee is a partnership of which the transferor is a member or a trust of which it is a beneficiary;

•    when the transfer takes place.

11. Draft legislation and explanatory notes are available on HMRC's website.

Further advice

12. If you have any questions about the changes regarding disguised interest, please contact Richard Rogers on 020 7147 2625 (email: richard.rogers@hmrc.gsi.gov.uk) or Richard Thomas on 020 7147 2558 (email: richard.thomas@hmrc.gsi.gov.uk). If your question relates to the transfer of a right to lease income, please contact Paul Lane on 020 7147 2637 (email: paul.lane@hmrc.gsi.gov.uk). Information about Budget measures is available on the HM Revenue & Customs website at www.hmrc.gov.uk