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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: index-linked gilt-edged securities: conditions

Conditions

In order for the anti-avoidance provisions at CTA09/S400A to apply, three separate conditions must be met:

Condition 1

Condition 1 at CTA09/S400A(2) is that a company is party to a ‘relevant hedging scheme’ at any time in an accounting period.

A ‘relevant hedging scheme’ is defined at subsection (6) as being ‘a scheme the purpose, or one of the main purposes, of any party to which, on entering into the scheme, is to secure that the index-linked capital return on the security, or a proportion of it, is hedged’. CFM39150 has further details.

Condition 2

Condition 2 at CTA09/S400A(3) is that there is an increase in the RPI between the times mentioned in subsection (1) of section 400 (i.e. between the start of the relevant accounting period (or if later the date of acquisition of the gilts) and the end of the accounting period (or if earlier the date of disposal of the gilts)).

This means that, in effect, the rules will only apply where the normal rules would act to take taxable credits out of account. Consequently, these rules will not apply to prevent deductions from being taken out of account for tax in the more unusual circumstance of the RPI decreasing between any two times.

Condition 3

Condition 3 at CTA09/S400A(4) is that the ‘index-linked capital return’ on the index-linked gilt-edged security, or a proportion of it, is ‘hedged’.

The ‘index-linked capital return’ is defined at subsection (7) as being that proportion of the increase in the carrying value of an index-linked gilt-edged security that is attributable to increases in the RPI. This is, therefore, referring to the return from holding the index-linked gilt that arises from increases in the RPI-linked final redemption amount.

The return on a security (or any proportion of that return) is defined as ‘hedged’ at subsection (8) where the ‘pre-tax economic profit or loss’ made by the ‘relevant group or company’, is not affected by the index-linked capital return from the index-linked gilt-edged security. This may be through the operation of a swap or otherwise.

CFM39160 has further detail on what is meant by the ‘pre-tax economic profit or loss’.

CFM39170 has further detail on what is meant by the ‘relevant group or company’.

Relevant Hedging Schemes

In order to meet condition 1 at CTA09/S400A(2) it is necessary that a company is party to a ‘relevant hedging scheme’.

This is defined at subsection (6) as being ‘a scheme the purpose, or one of the main purposes, of any party to which, on entering into the scheme, is to secure that the index-linked capital return on the security, or a proportion of it, is hedged’.

Consequently, it is not enough to be able to identify a return from an index-linked gilt-edged security that is hedged (i.e. paid away), but it must also be the case that the arrangements that resulted in the hedge must be part of a scheme that was entered into with that result in mind.

For example, it is perfectly normal for different companies within large groups in the financial sector to hold different positions with respect to index-linked returns and, in most cases, those positions would have been entered into independently of each other. These rules are intended to deal with cases where the ultimately equal and opposite transactions have been entered into with that result as a main purpose (or one of the main purposes). That will be a question of fact with reference to the individual circumstances of the relevant transactions.

Example 1

A company has a long-term commitment to a significant future liability. In order to remove the exposure to inflation implicit within the future commitment, the company purchases index-linked gilts.

This would not be a relevant hedging scheme. The company has not entered into a scheme or arrangement with a purpose of securing that the inflationary aspect of holding index-linked gilts is hedged. Rather, the existing exposure to inflation is being hedged through holding the index-linked gilts.

Example 2

A company invests in index-linked gilts and then enters into a total return swap, receiving a LIBOR-based interest rate and paying away an amount based on movements in the RPI.

As the main purpose, or one of the main purposes, of entering into the total return swap was to secure that the future inflation exposure on holding the index-linked gilts was hedged, then this would be a relevant hedging scheme.

Example 3

A company enters into a total return swap, receiving a LIBOR-based interest rate and paying away an amount based on movements in the RPI. A week later, the company purchases index-linked gilts with no purpose other than to provide the income that would be paid away under the total return swap.

As the main purpose of entering into the total return swap was to secure that the future inflation exposure on holding the index-linked gilts was hedged, then this would be a relevant hedging scheme. It does not matter that the total return swap was entered into before the index-linked gilts were purchased.