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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: reset bonds: use fair value basis

Conditions for S454 to operate

CTA09/S454 operates to bring in the bond at fair value, using mark to market, where

  • the object, or one of the main objects of the company in entering into the loan relationship was to secure a tax advantage. ‘Tax advantage’ takes its meaning from ICTA88/S840ZA
  • there has been a change in

    • the rate of interest payable, or
    • the amount payable on redemption, or
    • the time when payments, whether of interest or otherwise, fall due, and

there is at least a 5% difference in the value of the bond (comparing the fair value of the bond after the change with the issue price).

The example at CFM39050 satisfies these conditions. There is a change in the rate of interest payable, and the difference in value is 20% of the issue price.

Use fair value

Once the conditions are satisfied, that is, the change in terms has taken place, the company must use the fair value basis for the bond from that time onwards. S454(5) provides that fair value must assume that all amounts payable by the debtor will be paid in full as they fall due. In other words, fair value, for this purpose only, is determined without referring to the creditworthiness of the issuer.

Example

In the example at CFM39050, A Ltd carries the bonds in the accounts at issue cost £100,000 throughout, while the value of A Ltd itself fluctuates.

From the day on which the S454 conditions are satisfied, A Ltd will have to account for its bond using a fair value basis of accounting for tax purposes. So it starts from a market value of £80,000 even if the accounts themselves continue to use an amortised cost basis.

As the bond increases in value towards £100,000 at the date of redemption, the fair value basis of accounting ensures that credits of £20,000 are brought in over the life of the bond

Cases where S454 doesn’t apply

S454 is aimed at bonds where the underlying terms change. It is not intended to catch genuine commercial arrangements. Normal commercial bonds may have returns that vary over the life of the bond, but the original terms don’t change, for example

  • a stepped interest bond, or
  • a floating rate note, where the terms from the outset are to periodically set and reset the rate of interest to LIBOR, or another reference rate.

In addition, a loan between group members can be on variable terms and interest may be charged from time to time. Such arrangements are not caught by S454 unless the group is seeking a tax advantage.