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HMRC internal manual

Banking Manual

Bank loss restriction: targeted anti-avoidance rule: example of where the TAAR would apply

Example of where the TAAR would apply

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G Group uses inter-company derivatives to hedge.  G4 has substantial amounts of trading losses brought forward from before 1 April 2015.

G1 has an external floating rate loan liability of £1bn.

G2 holds an interest rate swap with a third party, hedging the cash flow risk in respect of G1’s loan. G2 receives floating, and pays fixed, interest on a notional principal of £1bn.

The swap and loan are linked via a third company in the group, G3, which has entered into back-to-back derivative positions with G1 and G2.  From G3’s perspective one of the swaps is in-the-money while the other is out-of-the-money. The use of a third company to link the positions is standard practice.

If G3 triggers the derivatives without any further steps then it will realise both a gain and a loss, with a neutral result.

Instead, having sustained the position for several years, in the accounting period to 31 December 2016 G3 transfers the in-the-money derivative on a group neutral basis to G4. This company then sells it, generating profit that is covered by brought forward losses. 

G3 then closes out the out of the money derivative realising a current year tax loss that can be used flexibly, thereby giving rise to a versatile current-year deduction that creates a tax benefit to the group by fully relieving otherwise taxable profits.

The group would always have realised a debit on the out-of-the money derivative, but because of the arrangement to transfer the in-the-money derivative to G4, there are increased profits in G4 and a tax benefit to the group. 

HM Revenue & Customs will have regard to any wider arrangements, but it is likely that the tax benefits to the group in transferring the derivative to G4 (the net tax saved in 50 percent relief in G4 against otherwise fully taxed income) is greater than any economic benefit from doing so.