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HMRC internal manual

Corporate Finance Manual

Loan relationships: tax avoidance: forex: non-arm’s length transactions: application of TIOPA10/Part 4: examples

Inward loan: does TIOPA10/Part 4 apply?

Example 1

Quodlines is a UK company which is wholly owned by a German company Quodlines GmbH. The UK company is funded with £1 share capital and a €1m interest-free loan. Sch 28AA does not apply because Quodlines Ltd is not obtaining any UK tax advantage. Therefore, exchange gains on the loan are fully taxed, and exchange losses fully relieved.

Example 2

Praslone Ltd is a UK subsidiary of a US company, Praslone Inc. The parent company makes a loan of $5 million to Praslone Ltd; the UK company pays interest of $300,000 on the loan. In the same period, an exchange gain of £250,000 arises on the loan. Praslone Ltd has already agreed with its tax inspector that the loan, in part, fulfils an equity function and that two-fifths of the interest would not have been paid in the absence of the parent/subsidiary relationship.

Although the UK company has borrowed $5 million from the US parent, it is agreed that an arm’s length, it would only have been able to borrow $3 million. Accordingly, only 60% of the interest paid by the UK company on the loan is allowed, the remainder being disallowed under TIOPA10/Part 4.

Under CTA09/S447, a similar restriction is made to exchange gains and losses on the loan. Thus, if the accounts show an exchange gain of £250,000 in the period, only £150,000 (60% x £250,000) is taxable.

Example 3

As above except the parent company makes two loans, a loan of $5m and one of €5m. The company pays 6% on both loans. In the same period an exchange gain of £250,000 arises on the dollar loan and an exchange loss £150,000 arises on the euro loan. As above it is agreed that two-fifths of the interest is re-characterised as a distribution. The same proportion - two-fifths - of the exchange gain on the dollar loan and exchange loss on the euro loan is disregarded. Therefore, in its tax computation the company will recognise a credit of £60,000 (net gain of £100,000 - (40% x £100,000)).