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HMRC internal manual

Corporate Finance Manual

Loan relationships: tax avoidance: forex: non-arm’s length transactions: non arm's length creditor relationships

Creditor relationship not at arm’s length

If a company makes a loan to an affiliate and either charges no interest at all, or charges interest at below market rates, it will frequently be appropriate to impute interest on the loan under the transfer pricing provisions. If the loan has no other non arm’s length features, the imputation of interest transforms it - for tax purposes - into a normal commercial loan. It is appropriate in these circumstances to fully allow exchange losses on the loan, and fully tax exchange gains.

On the other hand, it may be accepted in some cases that the loan fulfils an equity function in the accounts of the borrower, so that no transfer pricing adjustment under TIOPA10/Part 4 falls to be made. This does not mean that the loan is on arm’s length terms. The situation usually arises where a UK company is making a long-term investment in a subsidiary which is unable to fund interest payments. In such circumstances, an arm’s length lender, such as a bank, might not be prepared to advance a loan at all, or it would severely restrict the amount it was prepared to lend. Where a loan represents, wholly or in part, what is essentially an equity investment in an overseas company, it is not appropriate to recognise exchange gains and losses on the equity portion of the loan.

Under CTA09/S449 where:

  • the company would not have entered into the transaction giving rise to the loan had the parties been dealing at arm’s length, and
  • there is no corresponding debtor relationship,

exchange differences arising on the loan are disregarded.

CTA09/S450 explains how the term ‘corresponding debtor relationship’ applies to the amount of exchange gains and losses to be disregarded - CFM38570.

There is an exception where the outward loan exceeds an arm’s length amount - CTA09/S451 see CFM38580.