INTM551020 - Hybrids: financial instruments (Chapter 3): overview

Chapter 3 of Part 6A, TIOPA 2010 counters deduction/non-inclusion mismatches (D/NI mismatches) involving financial instruments. These are mismatches that

  • result in an allowable deduction that is not matched by a fully taxable receipt – a D/NI mismatch, and
  • arise from payments or quasi-payments (see INTM551080) made under, or in connection with, a financial instrument

Financial instruments for the purpose of Part 6A TIOPA 2010 are defined at s259N. The definition includes

  • arrangements where profits and deficits would fall within the loan relationship regime
  • contracts where profits and losses would fall within the derivative contracts rules
  • specific types of finance arrangements within Part 16 of CTA 2010
  • an issued share
  • arrangements that provide a person with economic benefits corresponding to those attaching to an issued share
  • a financial instrument as defined for UK generally accepted accounting practice (GAAP)

The definition excludes anything that is a regulatory capital security for the purposes of the Taxation of Regulatory Capital Securities Regulations 2013 (SI 2013/3209), see INTM551060.

An agreement for the transfer of a financial instrument is not expected in itself to meet the definition of a financial instrument but may be a hybrid transfer falling within Chapter 4, see INTM552000 onwards.

Conditions to be satisfied

For a deduction/non-inclusion mismatch arising from a financial instrument to fall within Chapter 3, four conditions; Conditions A to D must be met.

Condition A

  • there is a payment or quasi-payment involving a financial instrument

Condition B

  • at least one of the parties to the financial instrument is within the charge to UK corporation tax

Condition C

  • a mismatch would arise by reason of the terms or other specific features of the financial instrument or arrangements connected with the financial instrument (if that mismatch were not countered by this legislation or equivalent legislation outside the UK), and

Condition D

  • the parties to the financial instrument are related, or it is reasonable to suppose the financial instrument is a structured arrangement.

Extent of the mismatch

The extent of the mismatch depends on whether it falls within Case 1 or Case 2.

Case 1 deals with mismatches where

  • the deduction exceeds the total amount of ordinary income arising to payees, and
  • that excess is wholly or partly attributable to the terms or features of the financial instrument

The amount of the mismatch is the excess.

Case 2 deals with mismatches where

  • the income is under-taxed (that is, it is brought into charge as ordinary income, but at a lower rate than the highest rate that could be charged on income from financial instruments), and
  • the under-taxed amount is wholly or partly attributable to the terms or features of the financial instrument

The amount of the mismatch is the under-taxed amount.

For an explanation of what is included as ordinary income, see INTM550560 and INTM550570.

Counteraction

If all 4 conditions are met the mismatch is countered by

  • reducing the amount of the deduction claimed where the payer is within the charge to corporation tax in the UK, or
  • treating the relevant amount as taxable income where the payee is within the charge to corporation tax in the UK