A Q&A guide to tax on finance transactions in the UK (England and Wales). This Q&A provides a high level overview of finance tax in the UK (England and Wales) and focuses on corporate lending and borrowing (including withholding tax requirements), bond issues, plant and machinery leasing, taxation of the borrower and lender when restructuring debt, and securitisations.
To compare answers across multiple jurisdictions, visit the Tax on corporate lending and bond issues Country Q&A tool.
The Q&A is part of the PLC multi-jurisdictional guide to tax on finance transactions. For a full list of jurisdictional Q&As visit www.practicallaw.com/taxontransactions-mjg.
The main authority responsible for enforcing taxes on finance transactions in the UK is Her Majesty's Revenue & Customs (HMRC).
There are a number of statutory provisions under which formal clearance can be obtained from HMRC. It is also possible to obtain non-statutory or informal rulings from HMRC. As a general distinction, "formal clearance" refers to an application to HMRC under a statutory clearance procedure, whilst "non-statutory or informal ruling" refers to a less formal procedure whereby HMRC can be asked to clarify the correct tax treatment of a particular matter, for example, in view of material uncertainty in the relevant legislation. Neither "formal clearances" nor "non-statutory or informal rulings" are mandatory, though they are customarily sought in a variety of cases.
Withholding tax. A borrower that relies on a double tax treaty to pay interest without withholding UK income tax (or at a reduced rate of withholding) must obtain authorisation from HMRC before paying the interest gross (or at the applicable reduced rate of withholding). In order for the borrower to obtain that authorisation, the lender may be required to apply to HMRC under the 'certified claim' procedure. This involves the lender completing and submitting a form to HMRC describing the key terms of the loan entered into with the borrower. The lender must also apply to its domestic tax authorities for certification of its tax residence. If the lender's domestic tax authorities are satisfied with the lender's tax residence status, they will forward the claim to HMRC (or return certification of the lender's tax residence to the lender or its representatives for submission to HMRC). HMRC can then issue a direction to the borrower to make interest payments without, or at a reduced rate of, withholding. The application should be sent to: LBS DT Treaty Team, Barkley House, Castle Meadow Road, Nottingham NG2 1BA.
As an alternative to the 'certified claim' procedure described above, UK borrowers and overseas lenders may be able to take advantage of HMRC's double taxation treaty passport scheme (DTTP Scheme). This is generally a much more efficient way of obtaining relief from UK withholding tax under the UK's double tax treaties. Under the DTTP Scheme, an overseas lender in a country with which the UK has a double taxation treaty that includes an interest or income from a debt-claims article can apply to HMRC for a treaty passport, which will generally be valid for five years. HMRC will grant a passport and a scheme reference number (which is made available on a public database) where it believes an overseas lender is eligible. When a passport lender enters into a loan, it should notify the borrower that it wishes the DTTP Scheme to apply to that loan. The borrower is then required to notify HMRC that it has entered into a loan with the lender within 30 working days, using Form DTTP2. HMRC should then issue a direction to the borrower permitting it to pay interest without withholding or, if appropriate, at a reduced rate of withholding tax, as soon as is practicable after receiving the borrower's form.
Even if a lender holds a treaty passport, a borrower is not permitted to apply the treaty rate of withholding tax until it has received a direction from HMRC. There is, however, no obligation to use the DTTP Scheme, even after a lender has become a recognised passport holder. For those lenders who do not hold a passport, or who do not wish to use the DTTP Scheme for certain transactions, the normal 'certified claim' procedure remains available (as set out above).
Where a syndicated loan (that is, a loan made by several lenders) is made to a borrower, an appointed syndicate manager may wish to consider applying for clearance for interest to be paid gross by the borrower under the 'Syndicated Loan Scheme'. However, applications under this scheme are now less common where the lenders in a syndicate hold a DTTP Scheme passport.
Transfer pricing. A borrower can apply for clearance (in the form of an Advance Pricing Agreement or an Advance Thin Capitalisation Agreement) concerning the extent to which any intended tax deduction will be restricted by the UK transfer pricing rules. An application should be sent in the first instance to the HMRC Customer Relationship Manager (CRM) or Customer Co-ordinator (CC) for the borrower company or group. Where there is no CRM or CC, applications may be sent to HMRC, CTIAA Business International, 100 Parliament Street, London SW1A 2BQ, and should be copied to the borrower's local corporation tax office.
In general. It is possible to obtain an informal ruling from HMRC concerning the correct tax treatment of a particular transaction where the relevant legislation is contained in the last four Finance Acts (or relates to other primary and secondary legislation enacted during the same period). If there is material uncertainty concerning the correct tax treatment, and the issue is commercially significant to the taxpayer, such a ruling can also be applied for where the legislation is older than the last four Finance Acts.
UK arbitrage rules. A potential borrower can choose to apply for clearance under the material uncertainty rulings procedure where the borrowing could be considered to form part of a qualifying scheme to obtain a UK tax deduction involving either a hybrid instrument or a hybrid entity. Clearance, if obtained, will clarify the extent, if at all, to which the intended tax deduction will be available. The application should be made in the first instance to the CRM or CC for the borrower company or group. Where there is no CRM or CC, applications may be sent to HMRC, CTIAA Business International, 100 Parliament Street, London SW1A 2BQ.
Advance rulings for significant inward investment. The Inward Investment Support (IIS) department was set up by HMRC for significant inward investors (GB£30 million or more, or where investments are otherwise deemed by HMRC to be significant to the national or regional economy) to the UK. The services provided by the IIS include rulings across all taxes where there is uncertainty about the application of existing law. This can be useful in providing an indication of HMRC's attitude towards a particular finance transaction. This is likely to become increasingly important given the growing uncertainty and unpredictability of the UK's tax regime. Businesses (or their agents) may contact, Inward Investment Support, HMRC (CTIAA Business International), 100 Parliament Street, London SW1A 2BQ.
Where a borrower is party to a tax avoidance scheme with certain characteristics (hallmarks), there may be disclosure requirements. Where applicable, the promoter of a tax avoidance scheme relating to a finance transaction, or the borrower (assuming that it obtains a tax advantage) if there is no UK resident promoter, must disclose the scheme to HMRC under the Tax Avoidance Schemes (Information) Regulations 2004.
Intermediaries marketing schemes on behalf of promoters (known as "introducers") must also provide information to HMRC if provided with an information notice by HMRC.
If a finance transaction gives rise to certain types of value added tax (VAT) advantage, the company must disclose this under the VAT (Disclosure of Avoidance Schemes) Regulations 2004.
Lenders who have agreed to adhere to the Banking Code of Conduct may need to discuss the tax consequences of finance transactions with their CRM or CC before implementation if the tax effect of transactions differs from what may have been the expected result of the relevant legislation.
UK resident promoters must usually make the disclosure within five business days of first communicating information about a substantially designed scheme to a third party with a view to obtaining clients for the scheme. The borrower must disclose within five business days (if there is an offshore promoter) or 30 business days (if there is no promoter) of entering into the first relevant transaction. The disclosure must be made on the appropriate forms, and sent to HMRC, Anti-Avoidance Group (Intelligence), CTIAA Intelligence S0528, PO Box 194, Bootle, L69 9AA. The disclosures can also be made electronically. HMRC provides the promoter or the borrower with a reference number. The borrower must disclose this number on its tax return.
Where disclosure is required under the VAT (Disclosure of Avoidance Schemes) Regulations 2004, disclosure must be made in writing to HMRC VAT Avoidance Disclosures Unit, Anti-Avoidance Group (Intelligence), 22 Kingsway, London WC2B 6NR, (or by email) within 30 days of the relevant VAT return date or the date a claim is made.
Key characteristics. Assuming the lender is tax resident in the UK or carrying on a trade through a UK permanent establishment, interest and other profits receivable under a loan will be subject to UK corporation tax.
Calculation of tax. In most cases, interest and other profits receivable under a loan will be subject to UK corporation tax in accordance with the loan relationship legislation in Part 5 of the Corporation Tax Act 2009 (CTA 2009). These rules apply where a company stands in the position of a creditor or debtor as regards a money debt and that money debt arises from a transaction for the lending of money.
The broad effect of the loan relationship rules is to tax all profits and losses made by a company on its loan relationships broadly in accordance with their accounting treatment following Generally Accepted Accounting Principles (GAAP)/International Financial Reporting Standards (IFRS)). Therefore, interest and other profits receivable under a loan in an accounting period will generally be factored into a calculation of the lender's taxable profits based on the amounts recognised in the lender's accounts for that accounting period.
Triggering event. See above, Corporation tax: Calculation of tax.
Applicable rate(s). The main rate of UK corporation tax (for companies with non-ring fence profits (that is, not income and gains from oil extraction activities or oil rights in the UK and UK Continental Shelf) over GB£1,500,000) went down from 24% to 23% on 1 April 2013, and is set to reduce to 21% on 1 April 2014 and then to 20% on 1 April 2015.
The small companies' rate (20%) of corporation tax applies to companies with profits up to GB£300,000.
Where a company's profits fall between GB£300,000 and GB£1,500,000, marginal relief applies. This means that a company with profits over GB£300,000 but less than GB£1,500,000 will pay corporation tax at an overall rate that is over the small companies' rate but less than the main rate for that year. From 1 April 2015, when the main rate and small profits rate are set to be unified, marginal relief will no longer be relevant.
Under the loan relationship legislation in Part 5 of the CTA 2009, most borrowing costs should be deductible for UK corporation tax purposes in accordance with their accounting treatment (assuming that the borrower follows GAAP/IFRS).
If a loan relationship is entered into by a borrower for the purposes of its trade, UK corporation tax deductions (loan relationship debits) arising from its borrowing costs should be treated as an expense of that trade and will therefore generally be deductible when calculating the profit or loss of the trade for the relevant accounting period. Where a loan relationship is entered into by a borrower otherwise than for the purposes of its trade, any excess of loan relationship debits over loan relationship credits should give rise to a "non-trading deficit", which may be either:
Set off against profits of any description in the relevant accounting period.
Otherwise deducted in calculating the borrower's loss for the relevant accounting period.
It should be noted that various rules may apply to restrict the recognition of loan relationship debits (and non-trading loan relationship deficits). Relief may be restricted if the:
The loan relationship has an unallowable (that is, tax avoidance) purpose.
Costs have characteristics similar to equity and are characterised as a distribution (for example, where the amount of interest exceeds a reasonable commercial return).
Costs are paid on equity notes held, or funded, by an associated company (essentially, a note with no redemption date, or which has a redemption date more than 50 years after issue).
The following may also limit the level of tax relief available for interest or other finance costs:
Transfer pricing/thin capitalisation rules.
Worldwide debt cap.
Arbitrage rules.
Group mismatch rules.
Relief may be deferred where:
Interest is paid late.
The financing cost is on a deeply discounted security (that is, a security where the amount payable on maturity may exceed the issue price by a certain percentage) (see Question 17, Unpaid or deferred interest or capital).
These rules can apply to transactions between two companies under common control or management, or in certain circumstances where there is a 40% relationship between two companies. If the transaction is not conducted on arm's-length terms, transfer pricing adjustments may be required, limiting the deductions available for tax purposes. There is an exemption from the rules for small and certain medium-sized companies.
The UK's thin capitalisation rules aim to prevent a parent company seeking to extract profits from a subsidiary by financing the company with debt rather than equity. In the absence of these rules, a subsidiary could receive an excessive deduction for any interest payments it makes and thereby reduce or eliminate its taxable profits. Thin capitalisation is included as part of the UK's transfer pricing legislation. In line with the transfer pricing rules in general, the thin capitalisation rules seek to ensure that, for tax purposes, transactions are, on an arm's-length basis.
Legislation effective for periods of account beginning on or after 1 January 2010 means that UK members of multinational groups may have their overall tax deductions for finance costs limited by reference to the group's overall consolidated external finance costs. The general principle underpinning this "debt cap" is that UK corporation tax deductions for interest and other finance expenses (including the interest element in finance leases) claimed by members of a large group are restricted by reference to the group's consolidated external finance costs. This legislation seeks to prevent the UK part of worldwide groups obtaining tax deductions for finance costs from related companies, where there is a disproportionate level of finance expense in UK companies, relative to the group's overall external finance costs.
The arbitrage rules are aimed at preventing the exploitation of differences between or within national tax codes. The rules are divided between:
The deductions rules (where a scheme involving a hybrid entity or hybrid instrument increases a UK tax deduction or deductions to more than they would otherwise have been in the absence of the scheme).
The receipts rules (where an amount is received by a UK resident company in a non-taxable form while it creates a tax deduction for the payer).
Where the rules apply, a deduction can be denied to the extent that an amount may be deducted in calculating the profits of any other person.
These rules are aimed at countering tax advantages from transactions in loans and derivatives which arise from asymmetries in the way different members of corporate groups account for those transactions. In broad terms, these rules seek to counter schemes which give rise to a tax relief in one group company without a corresponding tax charge arising in another, meaning that the group incurs an overall tax loss without suffering an overall economic loss. Where these rules apply, profits and losses may be left out of account for UK tax purposes, meaning that tax relief may be denied.
Key characteristics. Profits and losses from "related transactions" (including any transfer, assignment or novation of a loan relationship) are generally subject to UK corporation tax under the loan relationships legislation in Part 5 of the CTA 2009 broadly in accordance with the accounting treatment show in the transferor's accounts.
Calculation of tax. See Question 4, Corporation tax: Calculation of tax.
Triggering event. See Question 4, Corporation tax: Calculation of tax.
Liable party/parties. See Question 4, Corporation tax: Calculation of tax.
Applicable rate(s). See Question 4, Corporation tax: Applicable rates.
Key characteristics. A transfer of a debt under a loan, and certain agreements to transfer a debt under a loan, are potentially subject to stamp duty or stamp duty reserve tax if the loan does not fall within a specific exemption known as the "loan capital exemption".
Calculation of tax. Stamp duty or stamp duty reserve tax will be charged on the amount of chargeable consideration paid. However, if the "loan capital exemption" applies, no stamp duty or stamp duty reserve tax will be payable. Broadly, the "loan capital exemption" will apply to any instrument that transfers loan capital (essentially all types of funded debt) unless any of the following apply:
The loan capital carries a right of conversion into shares or other securities of the same description.
The loan capital carries (or has carried) a right to interest that exceeds a reasonable commercial return for use of the principal.
The loan capital carries (or has carried) a right to interest that falls (or has fallen) to be determined, to any extent, by reference to the results of a business or to the value of any property.
The loan capital carries (or has carried) a right on repayment to a premium that is not reasonably comparable with what is generally payable under the terms of an issue of loan capital listed in the Official List.
Triggering event. Stamp duty will be triggered by the execution of an instrument of transfer in relation to stock or marketable securities. Stamp duty reserve tax will be triggered where a person enters into an agreement to transfer a chargeable security.
Liable party/parties. The stamp duty legislation does not expressly make any one person primarily liable to pay the duty. However, it is usually the buyer who pays it. The stamp duty reserve tax legislation makes the buyer liable to pay.
Applicable rate(s). Stamp duty and stamp duty reserve tax are charged at 0.5% of the chargeable consideration paid.
Income tax must be withheld from payments of annual interest which have a UK source. If the interest does not have a UK source, or the loan giving rise to the interest is only capable of lasting for less than a year and interest is not otherwise calculated on a yearly basis, there is no withholding requirement.
The current rate of withholding is 20% (subject to elimination or reduction under applicable double tax treaties).
No withholding is required where one of the following applies:
The borrower has a 'reasonable belief' that the person beneficially entitled to the payment is a UK tax resident company, or is a non-UK resident company carrying on a trade in the UK through a permanent establishment and the payment will be brought into account in calculating the profits of that trade for the purposes of UK corporation tax.
The interest is payable by a bank in the ordinary course of its business, or is payable on an advance from a bank where the person beneficially entitled to it is within the charge to UK corporation tax.
The interest is paid on a quoted Eurobond (that is, a security, issued by a company, which carries interest and is listed on a 'recognised stock exchange').
The lender is a 25% associate (for example, there is a direct 25% capital ownership relationship between the borrower and lender) which is liable to tax in another EU member state on the interest and HMRC has issued an exemption notice (in 2011, the European Commission adopted a proposal to reduce the minimum relationship to 10%).
The lender is tax resident in a jurisdiction with which the UK has a double tax treaty which provides for an exemption from UK withholding tax on interest payments, and HMRC has issued a direction stating that interest may be paid gross.
Certain other exemptions may also apply (for example, payments to charities or registered pension funds).
For a comparative summary of withholding tax on interest, see table, Withholding tax requirement on interest on corporate debt, and the key exemptions, in this multi-jurisdictional guide.
An area of uncertainty is whether guarantors that step in to satisfy a borrower's interest or principal repayment obligations may deduct that payment in computing their profits for UK corporation tax purposes. Arguably, the position depends on whether the guarantee in question is given in the course of the guarantor's trade:
If it is, it should be possible to claim a corresponding tax deduction on the basis that the guarantee payment is made "wholly and exclusively" for the purposes of the guarantor's trade (in keeping with section 54(1) of the CTA 2009).
If the guarantee is not given in the course of a trade, the position is much less clear. It may be possible to claim a deduction under the part of the loan relationship rules relating to "non-lending relationships", but this will depend on the facts in each case.
Under the UK's transfer pricing rules concerning thin capitalisation, the existence of guarantee arrangements may lead to tax deductions for interest payments being denied to a connected borrower (for example, a subsidiary of a parent company guarantor), to the extent that the borrowing is deemed to exceed the amount that could have been borrowed by the subsidiary on a stand-alone basis. Furthermore, the involvement of a parent company guarantor may lead to the imputation of a guarantee fee under the UK's transfer pricing rules.
Finally, if a guarantor makes a payment representing interest under a guarantee, it is uncertain whether this payment will itself be classified as interest for UK withholding tax purposes. This point remains largely unsettled, so it may also need to be considered whether UK income tax needs to be withheld from guarantee payments representing interest.
Bonds are not treated differently from standard corporate loans under the loan relationship rules for UK corporation tax purposes.
Issue of bearer bonds. BID is chargeable at the rate of 1.5% of the issue price on the issue in the UK of a bearer bond, or the issue of a sterling denominated bearer bond, by or on behalf of a UK company outside the UK.
Transfer of bearer bonds. BID is payable in the UK on the first transfer of the bond (but needs to be paid once only) at 1.5% of the transfer consideration where both:
No BID was payable on issue.
Stamp duty would be payable on transfer if the bond had been in registered form.
Stamp duty only applies in respect of written instruments and so is not, normally, relevant to bearer bonds, provided they are transferred by delivery. SDRT may apply on an agreement to transfer a UK bearer bond, at the rate of 0.5% of the consideration for the transfer, if the bond was exempt from BID on issue.
Issue of registered bonds. BID does not apply to registered bonds. There is usually no charge to stamp duty or SDRT on the issue of a registered bond. This is subject to special rules for issues into a depositary or clearing system, where SDRT of 1.5% can apply where either:
Registered bonds are issued to a depositary receipt issuer or its nominee and a depositary receipt is issued.
Registered bonds are issued into a clearing system (or its nominee) under an arrangement for the provision of clearance services.
However, it should be noted that, following the decision of the ECJ in HSBC Holdings plc v HMRC [Case C-569/07] and of the UK's First-tier Tribunal in HSBC Holdings PLC and another v HMRC [2012] UKFTT 163 [TC] (where it was held that the 1.5% SDRT charge is, in certain cases, contrary to EU law), HMRC will no longer seek to apply the 1.5% SDRT charge on the issue, or (where integral to the raising of capital) the transfer, of bonds into a clearing system or depositary receipt system (assuming that the bonds comprise loans raised by the issue of debentures or other negotiable securities for the purposes of Article 5(2)(b) of the Capital Duty Directive (2008/7/EC)).
In addition, in 2010 the High Court granted a group litigation order challenging the 1.5% charge, so this area may be subject to further change.
Transfer of registered bonds. The transfer of a registered bond will, potentially, give rise to a 0.5% stamp duty charge if the transfer either:
Is executed in the UK.
Relates to UK stock or marketable securities.
Relates to something done or to be done in the UK.
Any agreement to transfer a registered bond issued by a UK issuer or registered in a UK register may give rise to SDRT at a rate of 0.5%.
Transfer of bonds into clearance services or depositary receipt arrangements. This can give rise to stamp duty or SDRT at 1.5%. Note the points above regarding the circumstances in which the 1.5% charge will no longer apply and the High Court group litigation order.
No BID is payable on the:
Issue or transfer of a bearer bond if it relates to loan capital (whether or not it qualifies for the loan capital exemption described in Question 6, Stamp duty and stamp duty reserve tax).
Issue or transfer of a bearer bond outside the UK which is denominated in a foreign currency and which is not offered for subscription or transfer in the UK.
No stamp duty applies to bonds which qualify for the "loan capital exemption" described in Question 6, Stamp duty and stamp duty reserve tax, or where a transfer is executed outside the UK and has no UK nexus.
Bonds are exempt from SDRT if one of the following applies:
The bonds qualify for the "loan capital exemption" described in Question 6, Stamp duty and stamp duty reserve tax.
The issuer is not incorporated in the UK (unless the bonds are registered in a register kept in the UK).
In the case of an agreement to transfer a UK bearer bond which was exempt from BID on issue, no SDRT will apply if the bonds are:
Listed on a recognised stock exchange.
Not convertible into, and do not carry a right to, the acquisition of shares or other securities that are not listed on a "recognised stock exchange".
Not issued in connection with a takeover of the issuer.
The basic rule is that capital allowances are available to the lessor under a non-long funding lease of plant and machinery where the lessor:
Is carrying on the trade of (or including) the leasing of plant and machinery.
Has incurred capital expenditure on the plant and machinery wholly and exclusively for the purposes of its trade.
Is the beneficial owner of the plant and machinery as a result of the capital expenditure incurred.
Capital allowances will generally be available to the lessee under a long funding lease of plant and machinery.
The following are examples of leases which will be treated as non-long funding leases of plant and machinery:
Leases that are hire-purchase transactions or other types of finance lease transactions where the lessee automatically acquires, or has the option to acquire, the asset.
Leases of plant and machinery that is fixed or installed on to land where the plant and machinery is of a kind that would ordinarily be installed, and the sole or main purpose of which is to contribute to the functionality of a building or its site (known as "background plant and machinery").
Most leases of ships to companies within the UK's tonnage tax regime.
Leases of a term of not more than five years.
Leases of a term between five and seven years, provided that both:
the residual value implied in the lease is not more than 5% of the fair value of the asset at commencement;
the rentals due in any year do not vary by more than 10% year-on-year (other than as a result of changes in interest rates).
Leases where a superior lessor is (or would be, if it were UK tax resident) entitled to capital allowances.
The rate of capital allowances for plant and machinery in the general pool is 18% from 1 April 2012.
A special rate pool exists for:
Plant and machinery which qualifies as an "integral feature" (set out in section 33A of the Capital Allowances Act 2001 (CAA 2001)).
Thermal insulation added to an existing non-residential building.
"Long life assets" (broadly, plant and machinery with an expected useful economic life, when new, of 25 years or more).
The rate of capital allowances for plant and machinery in the special rate pool is 8% from 1 April 2012.
There are 100% "enhanced capital allowances" for qualifying expenditure incurred on designated energy-saving plant and machinery and environmentally beneficial plant and machinery.
Finally, there is a 100% "annual investment allowance" for certain qualifying expenditure on plant and machinery, subject to certain conditions and anti-avoidance provisions. From 1 January 2013 to 31 December 2014, this applies to the first GB£250,000 of qualifying expenditure (but is scheduled to revert to GB£25,000 on 1 January 2015).
There have traditionally been rules to restrict the availability of capital allowances where plant and machinery is leased to a lessee who is not resident in the UK for tax purposes, and who does not use the equipment exclusively for the purposes of a trade carried on in the UK. These rules were amended in 2006 and no longer apply to leases entered into on or after 1 April 2006. HMRC issued a Brief in May 2007 (HMRC Brief 40/07) confirming that where the rules continue to apply and plant and machinery is leased to a lessee resident in an European Economic Area (EEA) state, and that EEA state gives the lessee a relief that is broadly equivalent to capital allowances, a rule precluding the availability of UK capital allowances (section 110, CAA 2001) will not be applied. However, a rule restricting the rate of capital allowances to 10% (section 109, CAA 2001) will be applied. Where the relevant EEA state does not give the lessee a relief that is broadly equivalent to capital allowances, the lessor will be entitled to capital allowances at the normal rate.
The taxation of rentals under leases depends upon the type of lease.
If the lease is a long funding lease, the taxation of the lessor will in turn broadly depend on whether the lease is a finance lease or an operating lease.
Finance lease. If the lease is a finance lease, the lessor will normally be taxed under section 360 of the Corporation Tax Act 2010 (CTA 2010) on the amount of rental earnings in respect of the lease for the relevant accounting period. The amount of these rental earnings is expressed in that section to be the gross return on investment recognised in an accounting period in respect of the lease in accordance with GAAP. If the lessor accounts for the lease as a loan, any rentals which are accounted for as interest in an accounting period are taxed as rental earnings.
Operating lease. If the lease is an operating lease, the lessor's accounts would not contain the figures that will enable it to be taxed on its gross return. Instead, the lessor will be taxed on its rental income less a deduction equal to the expected gross reduction in value over the term of a lease which is attributable to the relevant accounting period. This is effectively an amount representing straight-line depreciation from the cost of the plant and machinery to its residual value over the lease term, apportioned to each accounting period during the lease term (sections 363-365, CTA 2010).
The lessor under a non-long funding lease will normally be taxed on its rental income recognised on an accruals basis in accordance with GAAP. As noted in Question 12, lessors under non long-funding leases may claim capital allowances for qualifying expenditure incurred on plant and machinery.
It is not necessary to obtain a ruling or clearance from HMRC in connection with plant and machinery leasing.
Borrowers will generally be able to obtain a tax deduction (loan relationship debit) for interest as it accrues and lenders will recognise a taxable receipt (loan relationship credit) for interest income as it accrues. However, under rules governing the late payment of interest, where interest accrues on debt between "connected" parties but is not paid within 12 months of the end of the accounting period, and the full amount of the interest is not brought into account for corporation tax purposes by the lender, the borrower will not in certain circumstances obtain a loan relationship debit for the interest accrual until the interest is actually paid by the borrower (sections 372 and 373, CTA 2009).
Following amendments made by the Finance Act 2009 (principally to counter arguments that the UK's rules infringed the EU principle of freedom of establishment), the late paid interest rules now apply in a narrower set of circumstances. Broadly, for the late paid interest rules to apply, either:
The borrower must control the lender, or vice versa, or both must be under the control of the same person.
The borrower must be a "close company" and the lender must be a participator or an associate of a participator.
The borrower must have a "major interest" (broadly designed to capture joint ventures where the main two co-venturers each have at least a 40% interest) in the lender, or vice versa.
In each of the above cases, the lender must be either resident in a "non-qualifying territory" or effectively managed in a "non-taxing non-qualifying territory". A "non-qualifying territory" is, broadly, a territory with which the UK does not have a double tax treaty containing a non-discrimination article.
Where discounted debt is issued as an alternative to interest bearing debt, sections 406 to 412 of the CTA 2009 may apply to deny a loan relationship debit to the borrower in respect of the discount until the accounting period in which the discounted security is redeemed (subject to similar qualifications as are described above in relation to the late paid interest rules).
For lenders accounting for a loan on an amortised cost basis, a loan relationship debit should be allowed for recognised accounting impairment losses. However, as an exception to the general rule, a lender may not bring into account a loan relationship debit in respect of an impairment loss where there is, at any time in the accounting period of the release, a connection between the parties (save in the case of a debt for equity swap where there was no prior connection between lender and borrower, or where the lender is the subject of insolvent liquidation, insolvent administration or certain other insolvency procedures referred to in section 357 of the CTA 2009).
Written off or released (wholly or partly)?
Replaced by shares in the borrower (debt for equity swap)?
Writing off or release
As a general rule, the writing off or release of a loan (in whole or in part) will result in a corresponding taxable receipt (loan relationship credit) for the borrower, and a tax deduction (loan relationship debit) for the lender, in each case matching the amounts which are recognised in the accounts of the borrower and lender as a profit or loss in respect of the writing off or release of the loan.
This general rule is subject to certain exceptions. In particular, a borrower should not be treated as having accrued a loan relationship credit in respect of the release of its obligations under a loan where an amortised cost basis of accounting is applied to the loan in the relevant accounting period, and either:
The borrower and lender are "connected" in the relevant accounting period (this may be satisfied where there is a connection at any time in the relevant accounting period). In this instance, the lender will also not obtain a loan relationship debit in respect of the writing off or release of the loan (except in the case of a debt for equity swap where there was no prior connection between lender and borrower, or where the lender is the subject of insolvent liquidation, insolvent administration or certain other insolvency procedures referred to in section 357 of the CTA 2009).
The release is part of a "statutory insolvency arrangement" as defined in section 1319 of the CTA 2009.
The lender is:
the subject of insolvent liquidation, insolvent administration or certain other insolvency procedures referred to in section 357 of CTA 2009; and
was immediately before the insolvency procedure connected with the borrower but immediately after that time was not connected with the borrower (section 359, CTA 2009).
The borrower is the subject of an insolvency procedure referred to in section 322(6) of the CTA 2009 and the parties are not connected (section 322(5), CTA 2009).
The release is in consideration of, or of any entitlement to, an issue of ordinary share capital by the debtor company (section 322(4), CTA 2009) (see below, Debt for equity swap).
The general rule is that a borrower will not be required to bring into account a loan relationship credit where it is released from its obligations under a loan, provided that both:
The release is in an accounting period for which an amortised cost basis of accounting is used.
The release is in consideration of the issue of ordinary shares (section 322(4), CTA 2009). It is important to ensure that the debt is released "in consideration of" the issue of ordinary shares and does not amount to a mere release of a debt.
For its part, the lender should be able to obtain a loan relationship debit equal to the difference between the carrying value of the capitalised loan and its market value on the date of the debt for equity swap. If there is a connection between the lender and the borrower before the debt for equity swap, no loan relationship debit can be brought into account.
A specific tax regime exists in the UK for "securitisation companies" under the Taxation of Securitisation Companies Regulations 2006 (SI 2006/3296) (Securitisation Regulations).The most common type of securitisation company falling under the Securitisation Regulations is a "note-issuing company" (broadly, a special purpose vehicle (SPV) which issues notes with an aggregate value of at least GB£10 million wholly or mainly to independent persons, and whose activities only comprise acquiring and holding financial assets as security for issued notes). Various other categories of securitisation company exist under the Securitisation Regulations, including:
Asset-holding companies. Broadly, companies whose activities only comprise acquiring, holding and managing financial assets as security for notes issued by a note-issuing company.
Intermediate borrowing companies. Broadly, companies whose activities only comprise lending money to an asset-holding company or another intermediate borrowing company.
Warehouse companies. Broadly, companies whose activities only comprise acquiring and holding financial assets to transfer to a note-issuing company or an asset-holding company, or with a view to becoming a note-issuing company or an asset-holding company in their own right.
Commercial paper funded companies. Broadly, companies that have been asset-holding companies or intermediate borrowing companies, but whose loan debts to a note-issuing company (or, for asset-holding companies, to an intermediate borrowing company) have been transferred to, or substituted for debts owed to, a bank.
Under the Securitisation Regulations, a securitisation company must pay out all of its income within 18 months of the end of the accounting period in which receipt occurs, except for its retained profit and certain other amounts (for example, amounts reasonably required to provide for losses or expenses arising from its business). Further, a securitisation company must not have an "unallowable purpose" in entering into a transaction. Broadly, this means either:
A purpose which is not among the business or commercial purposes of the company.
Where the main purpose (or one of the main purposes) of the securitisation company in entering into the transaction (or any part of it) is to secure a tax advantage.
Where a securitisation company satisfies the conditions under the Securitisation Regulations, it should only be subject to tax on its retained profit (that is, cash remaining in the company at the end of an accounting period). The amount of retained profit may be minimal. If a securitisation company does not have enough funds to retain as much profit as it intended under the securitisation structure, the company is taxed only by reference to the actual retained profit and any shortfall can be made good in subsequent periods. In addition, certain UK tax rules will be disapplied in relation to securitisation companies, including that interest paid by a securitisation company may not be re-classified as a non-deductible distribution.
For companies which do not qualify as securitisation companies under the Securitisation Regulations (for example, where securitised assets are not financial assets), it will be necessary to consider how tax efficiency can best be achieved, subject to making a minimum level of profit. HMRC previously stated in its guidance that one basis point would be acceptable, but no longer stipulates a specified level of profit.
It should also be noted that a temporary tax regime exists for securitisation SPVs with periods of account ending before 1 January 2017. Broadly speaking, under this regime, companies are taxed under the loan relationship rules as if old UK GAAP (that is, UK GAAP as it stood at 31 December 2004) still applied. This would normally be expected to produce a result for the SPV that follows its economic position.
Furthermore, an additional specific regime has been enacted in the UK to govern the taxation of insurance securitisations. Broadly, the regulations are intended to put securitisations for insurance SPVs on the same footing as securitisations of financial assets.
In addition to the tax treatment of securitisation SPVs, various UK tax issues may need to be examined in detail in relation to securitisation transactions with a UK nexus, including withholding tax, stamp taxes and VAT.
In the June 2010 Budget, the UK government announced that it would consider introducing a legislative general anti-avoidance rule. Following the independent study led by Graham Aaronson QC and the subsequent consultation from June to September 2012, legislation has been proposed for a general anti-abuse rule (GAAR) to counteract tax advantages arising from 'abusive' tax avoidance schemes. The GAAR will cover income tax, corporation tax (and amounts treated as corporation tax), capital gains tax, inheritance tax, stamp duty land tax, the annual tax on enveloped dwellings and petroleum revenue tax. The legislation will apply to tax arrangements undertaken on or after the date of Royal Assent to Finance Bill 2013.
Separately, it has been confirmed that, following the conclusion of the Capital Requirements Directive IV (CRD IV), secondary legislation will be produced to confirm and ensure that banks' Additional Tier One debt capital instruments, both already in issue and yet to be issued, will be deductible for banks for the purposes of computing their profits for UK corporation tax. Draft legislation had already been published (in December 2012) for inclusion in Finance Bill 2013 with the intention of ensuring the deductibility of coupons on CRD IV-compliant Tier Two regulatory capital instruments, and to prevent such coupons being treated as distributions for UK corporation tax purposes. The legislation also sought to clarify that loans forming part of a bank's Tier Two capital will be regarded as 'normal commercial loans', such that holders of a bank's Tier Two capital will not be treated as 'equity holders' in the bank (which is helpful for the purposes of the group relief 'economic ownership' test).
Finally, there are two international measures likely to have a significant impact on the taxation of finance transactions in the UK:
Firstly, the government is shortly to issue regulations to implement the UK-US Foreign Account Tax Compliance Act (FATCA) agreement, signed on 12 September 2012. The compliance obligations imposed by these regulations will significantly affect financial institutions within scope.
Secondly, ongoing discussions on the financial transaction tax (FTT) proposed by the European Commission are being closely monitored as the "issuance" principle (under which financial instruments issued in the 11 'FTT zone' states will be taxed even if those trading them are not established within the FTT zone) threatens finance transactions carried out in the UK as elsewhere.
T +44 20 3130 3645
F +44 20 3130 8951
E sbhogal@mayerbrown.com
W www.mayerbrown.com
Qualified. England and Wales, 2002
Areas of practice. Tax transactional advice on matters involving corporate finance, banking, capital markets, asset finance and real estate; corporate tax planning including advising on the development of domestic and cross-border tax efficient structures.
T +44 20 3130 3552
F +44 20 3130 3001
E bfryer@mayerbrown.com
W www.mayerbrown.com
Qualified. England and Wales, 2009
Areas of practice. Corporate tax.
