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HMRC internal manual

Corporate Finance Manual

Deemed loan relationships: disguised interest: tax avoidance purpose

Meaning of tax avoidance purpose

Even though the disguised interest rules set out a number of conditions that must be met in order for the rules to apply, it is still possible that the rules could catch perfectly acceptable, commercial-driven transactions that have no tax avoidance motive.

CTA09/S486D contains a very important feature of the disguised interest rules. This provides that the disguised interest rules do not apply…

‘…unless it is reasonable to assume that the main purpose, or one of the main purposes, of the company being a party to the arrangement is to obtain a relevant tax advantage.’

This means that unless the purpose (or one of the main purposes) of the arrangements is to obtain a ‘relevant tax advantage’, then the disguised interest rules cannot apply. Consequently, the disguised interest rules should not inadvertently catch commercially-driven transactions with no purpose of obtaining a ‘relevant tax advantage’ that just happen to fall within the specific conditions for the disguised interest rules to apply.

‘To obtain a relevant tax advantage’ is defined in S486D(4) as meaning to secure that the return is produced in such a way that means it would be taxed more favourably than it would be if it were charged to tax as income or brought into account as income at the time that the return would be recognised under the disguised interest rules.

This purpose test requires consideration of two questions:

  • Whether, as a matter of fact, the return produced by the arrangements for the company is produced in a form (e.g. capital gain or dividend) that would be taxed more favourably than it would be if that return were taxed in the same way as interest.
  • Whether it is reasonable to assume that it was a main purpose of the company being party to the arrangements to secure that the return was produced for it so as to give rise to that advantage.

S486D(5) makes it clear that the tax avoidance exclusion does not apply where the return is produced for a company that is a controlled foreign company (CFC).

Where a question of purpose arises the matter should be referred to Anti-Avoidance Group.


It is possible that some companies may enter into arrangements that were specifically structured so that they fall within the disguised interest rules. This would allow the tax treatment of the value of the shares to be brought into line with their amortised cost-based accounting treatment or, possibly, to achieve a post tax hedge.

These arrangements would not fall within the disguised interest rules because they will not have a tax avoidance motive. Consequently, companies have the option of electing out of the tax avoidance purpose test so that they are within the disguised interest rules regardless of their motive of entering into the arrangements.

The election cannot be made by a company where the disguised interest rules apply due to S486B(6) (CFM42080).

The election must be made no later than the time when the arrangement begins to produce a return for the company and any election, once made, is irrevocable.