CFM37330 - Loan relationships: special types of security: deeply discounted securities: connected companies and close companies: changes made by Finance Act 2015

FA15/S25

What changes were made?

FA15/S25 limited the circumstances to which the rules apply. It also made a similar limitation to the categories of connection to which the late interest rules (CFM35800) at CTA09/S373 apply for loan relationships.

The late paid interest and deeply discounted security rules were originally introduced to counter tax asymmetries between the lender and borrower to a loan. However, these provisions have been deliberately exploited by some companies to increase the amount of tax relief they can obtain for interest expense.

The special rules for deeply discounted securities originally applied where:

  • There is a connection between the issuing company and the creditor company: S407 (CFM37240)
  • A close company issues a DDS and the creditor is a participator: S409 (CFM37260)

The first bullet has now been removed. As a result, the rules now only apply where a close company issues a deeply discounted security and the creditor is a participator.

Commencement and transition

New securities

The changes apply to securities issued on or after 3 December 2014.

The DDS rules will therefore not apply if connection between the debtor and creditor was through the conditions of S408. The rules will continue to apply if a close company issues a deeply discounted security to a participator.

Existing securities

In cases where a DDS was issued by a company before 3 December 2014 the existing rules continue for any discount accrued on or before 31 December 2015.

If the discount had been disallowed on the basis of S407, then any discount accruing in the subsequent periods will be allowable as it accrues, rather than when the instrument is redeemed.

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

Therefore debits accruing in the first notional period will be disallowed, but debits accruing in the second notional period will be allowed.

Modified loans

However, the extended treatment does not apply where there has been a material change in the terms of the security, or there is a change in the person standing in the position of creditor. In particular, this would be the case where:

  • The amount of the security is substantially increased.
  • The term of the security is substantially extended.
  • The security is transferred to a tax haven.

In such cases the changes to the deeply discount security rules will apply from the date of the modification.

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

Previously accrued discounts

Where discounts have previously been disallowed under the DDS rules, the effect of the rules continues to apply in respect of these amounts that have already accrued. As a result, relief for these amounts will be available at the time it is redeemed (subject to other statutory provisions).