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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Loan relationships: tax avoidance: forex: non-arm’s length transactions: deemed loan relationship of guarantor

Debtor loan relationship under TIOPA10/Part 4

This guidance applies to accounting periods ending on or after 6 December 2006

FA07 amended the legislation relating to exchange gains and losses on non-arm’s length transactions, for accounting periods ending on or after 6 December 2006, except in relation to loan relationships to which it has ceased to be a party before that date.

TIOPA10/Part 4 deals with transfer pricing where there are loans made between associated persons otherwise than on an arm’s length basis but it does not deal with exchange gains and losses on such loans. CTA09/S447 generally provides that exchange gains and losses are disregarded to the same extent that interest on the loans is disallowed. However, the changes under FA07 deal with a scheme that attempts to obtain tax relief for exchange losses in circumstances where if an exchange gain arose the gain would not be taxable.

Under the scheme, parent company (‘PCo’) lends money (‘Internal Loan’) to its subsidiary (‘SubCo’). SubCo would have been unable to borrow at arm’s length terms so is supported by a guarantee from a fellow subsidiary (‘Guarantor’) who would have been able to take out a loan. The Internal Loan is funded by a loan from a third party lender (‘External Loan’). Each loan is made in an overseas currency. SubCo’s exchange exposure is hedged by a shareholding in a subsidiary company whose shares are denominated in the foreign currency.

A claim can be made under TIOPA10/S192 for the Guarantor to be treated as the issuer of the Internal Loan. In this way, debits for which relief is denied by Part 4 to PCo (issuer of the loan) are allowed instead to the Guarantor. Such a claim is not mandatory and can be made year by year. Therefore, in a year when the overseas currency strengthens, an allowable loss arises to PCo on the External Loan. There would be no exchange gain on the Internal Loan because the loan would never have been made on arm’s length terms, and therefore, no claim will be made under S192. In a year when the overseas currency weakens, there would be a taxable exchange gain arising to PCo on the External Loan in which case there will be a claim under S192 so relief becomes available for PCo’s corresponding exchange loss on the Internal Loan, making the group flat in tax terms.

The amendments ensure that exchange gains and losses are treated in the same way by deeming a claim under S192 to be made where there is no actual claim.