CFM33030 - Loan relationships: Core rules: what is interest?
CTA09/S306A(1)(b)
What is interest?
Interest is the most common example of the amounts that can arise under a loan relationship and which can therefore be brought into account under the loan relationship regime.
There is no statutory definition of interest for tax purposes. The simplest explanation of interest is payment by time for the use of money. In addition, interest can also represent compensation for the denial of the use of money due from another.
For interest to exist there must be a principal sum; that is, a sum of money advanced or a debt incurred, or an amount withheld or lost between the parties.
Interest can only arise by virtue of a legal right; a voluntary or gratuitous payment cannot be interest.
What is interest: case law
The question of what constitutes interest has been the subject of much case law over the years. Perhaps the best known quotation on what interest is comes from Rowlatt J in Bennett v Ogston (15TC374). He described interest as ‘payment by time for the use of money’.
This theme was developed in Westminster Bank v Riches (28TC153) where it was said ‘… the essence of interest is that it is a payment that becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have if he had had the use of the money, or conversely the loss he suffered because he had not had that use.’ The general idea is that he is entitled to compensation for the deprivation.
The requirement that for interest to exist there must be a principal sum from which the interest originates was considered in Re Euro Hotel (Belgravia) Ltd (51TC293). In his judgement Mr Justice Megarry said ‘there must be a sum of money by reference to which the payment which is said to be interest is ascertained.’
The concept that interest is something that accrues over time is supported by the cases of Wigmore v Thomas Summerson (9TC577) and Willingale v International Commercial Bank (52TC242). These cases indicated that true interest accrues from day to day or at periodic intervals.
What constitutes interest is a question of legal substance rather than terminology. In his judgement in the Re Euro Hotel case, Mr Justice Megarry said ‘It has, quite rightly, not been suggested that the language used by the parties to an instrument in describing the payment to be made under it can bind the Inland Revenue, or affect the operation of the statute. The question must always be one of the true nature of the payment.’
The case of Seaham Harbour Company v Crook (16TC333) demonstrates that a voluntary or gratuitous payment cannot be interest. This is so even if the payment is paid in lieu of or is equivalent to interest.
Certain amounts are treated as if they are interest for the purposes of the loan relationships rules - see CFM33040.
There is more on the case law on interest in the Savings and Investment Manual (SAIM2030+).
What is interest: accounting treatment
Note that in accounting terminology, 'interest' can have a wider meaning and include amounts with a similar economic nature, such as the funding costs under leasing. How an amount is described in the accounts does not determine whether it is an amount of interest for tax purposes.
Further guidance
Interest characterised as a distribution
Subject to exceptions in tax avoidance cases, CTA09/S465 excludes interest or discount characterised as a distribution from the loan relationships rules. See CTM15530 for the treatment of certain interest amounts as a distribution for the purposes of Corporation Tax.
Interest on non-lending relationships
Where interest arises on a money debt that is not a loan relationship, the interest may nevertheless be brought into account under the loan relationship rules through the operation of CTA09/PT6. This would typically apply, for instance, to interest on trade debts and judgement debts. See guidance beginning at CFM41000 for further details.