CFM35985 - Loan relationships: connected parties: late interest: changes made by Finance Act 2015

FA15/S25

What changes were made?

FA15/S25 limited the categories of connection to which the late interest rules applies. It also made a similar limitation to the deeply discounted security rules at CTA09/S406-S412.

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 original categories of connection, were:

The first and third bullets have now been removed. As a result, the categories of connection is limited to:

  • Connection through participation in a close company: S375
  • Connection through a pension scheme: S378

Commencement and transition

New loans

The changes apply to loans entered into on or after 3 December 2014.

The late interest restriction rule will therefore not apply to interest debits on a loan relationship if connection between the debtor and creditor was only through connection through control (S374) and connection through major interest (S377). The late interest rules will continue to apply if either of the other two categories are satisfied.

Existing loans

In cases where a loan was entered into by a company before 3 December 2014 the existing rules continue for interest accrued on or before 31 December 2015.

If the interest had been disallowed on the basis of S374 or S377, then any interest accruing in the subsequent periods will be allowable as it accrues, rather than when it is paid.

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 relationship, or there is a change in the person standing in the position of creditor. In particular, this would be the case where:

  • The amount lent under the loan is substantially increased.
  • The term of the loan is substantially extended.
  • The loan receivable is transferred to a tax haven.

In such cases the changes to the late interest 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 interest

Where interest has previously been disallowed under the late interest rules, the effect of S373 continues to apply in respect of the interest. As a result, relief for this interest will be available at the time it is paid (subject to other statutory provisions).

Examples

Example 1:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is a UK resident company.

A Ltd lent £1,000,000 to B Ltd on 10 June 2014 at 2.5% interest per annum. B Ltd includes an interest expense for the accounting periods ended 31 December 2014 and 31 December 2015, and at 31 December 2016 the accrued interest remains unpaid.

The interest is ‘late’ and it has not been brought in to account by A Ltd. Conditions A and B of S373/CTA09 are therefore met.

The late interest rule will therefore disallow any loan relationship debit for the unpaid interest for the periods ended 31 December 2014 and 31 December 2015 on the basis of connection through major interest in S377/CTA09. Relief for this interest will be available on a paid basis.

For accounting periods from 31 December 2016 the interest will be allowable as it accrues.

Example 2:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is a UK resident company.

A Ltd lent £1,000,000 to B Ltd on 10 June 2014 at 2.5% interest per annum. B Ltd includes an interest expense for the accounting period 1 July 2015 to 30 June 2016, and that interest remains unpaid at 30 June 2017.

The interest is ‘late’ and has not been brought in to account by A Ltd. Conditions A and B of CTA09/S373 are therefore met.

The company has two notional accounting periods. In the notional period ended 31 December 2015, the debit for the accrued interest is disallowed. Relief will be available on a paid basis.

For the period ended 30 June 2016, S377 no longer applies and the interest is allowed as it accrues.

Example 3:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is resident in the UK.

A Ltd lent £1,000,000 to B Ltd on 10 December 2014 at 2.5% interest per annum. B Ltd includes an interest expense in the accounting periods ended 31 December 2014 and 31 December 2015, and the accrued interest remains unpaid at 31 December 2016.

The interest is ‘late’ and has not been brought in to account by A Ltd. Conditions A and B of S373/CTA09 are therefore met.

As this debtor relationship was entered in to after 3 December 2014, S377 no longer applies. There will be no restriction on the interest debit for B Ltd under S377 and the interest is allowed as it accrues.

Example 4:

A Ltd has a major interest in B Ltd. A Ltd is resident for tax purposes in a non-qualifying territory and B Ltd is resident in the UK.

A Ltd lent £1,000,000 to B Ltd on 10 June 2014 at 2.5% interest per annum. B Ltd includes an interest expense in the accounting periods ended 31 December 2014 and 31 December 2015, and the accrued interest remains unpaid at 31 December 2016.

The interest is ‘late’ and has not been brought in to account by A Ltd. Conditions A and B of S373/CTA09 are therefore met.

For the period ended 31 December 2014, CTA09/S373 applies to disallow any loan relationship debit claimed by B Ltd on the basis that A Ltd has a major interest in B Ltd under S377. Relief will be available on a paid basis.

On 1 July 2015, there is a material change in the terms of the loan relationship.

For the year ended 31 December 2015, the company is treated as having two notional accounting periods. In the notional period ended 30 June 2015, the debit for the accrued interest is disallowed. Relief will be available on a paid basis. For the period ended 31 December 2015, S377 no longer applies and the interest is allowed as it accrues.