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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Loan relationships: tax avoidance: forex: non-arm’s length transactions: debtor relationship: interest on equity notes treated as distribution

Interest is treated as a distribution: periods beginning on or after 1 April 2004

For periods ending before 1 April 2004, ICTA88/S209(2)(da) operated as a counter to thin capitalisation (where a foreign investor funds a UK company principally through debt, and extracts profits from the company by means of tax-deductible interest rather than dividends).

ICTA88/S209(2)(da) was repealed by FA 2004, as part of changes to the transfer pricing rules in ICTA88/SCH28AA (now TIOPA10/Part 4), for accounting periods beginning on or after 1 April 2004. Where an accounting period straddles 1 April 2004, it is treated as though it were two separate periods: the amended provisions apply from 1 April 2004 onwards.

The legislation that is now at CTA09/S448 was therefore also amended, and after 1 April 2004 applies only where ICTA88/S209(2)(e)(vii) (rewritten to CTA10/Part 23) treats interest on a security as a distribution where the UK company is funded by equity notes. These are instruments that would otherwise be treated as debt for UK tax purposes, but have features similar to shares and may be treated as equity by some overseas tax jurisdictions. CTM15515 gives further details.

If the whole of the interest on the UK company’s debt falls to be treated as a distribution under this provision in a particular accounting period, then any exchange gains and losses arising on the debt in that period are disregarded. The whole of the debt is seen as performing an equity function. It is therefore reasonable to ignore exchange gains and losses on the debt.

A security will either be an equity note, or it won’t - there is no provision for only part of a security to come with S209(2)(e)(vii). So unlike the position prior to 1 April 2004, there is no rule for a ‘proportionate part’ of exchange gains or losses to be left out of account.