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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Deemed loan relationships: alternative finance: example of profit share agency arrangements

Example of profit share agency arrangements

Bank M (a financial institution) decides to offer its customers the opportunity to invest in a profit share agency arrangement. Customer X decides to invest £10,000 in such an arrangement for a period of one year and accordingly appoints Bank M as his agent to invest in an outside company. The arrangement between Bank M and X sets out that X is entitled to any profit made on the investment, up to a maximum of 4% (£400) of the original investment. In addition, X is to pay Bank M an agency fee of £50 for acting as agent in this arrangement.

Bank M accordingly invests £10k for a period of one year in an outside company and makes a return of 6% (£600). X is treated as only entitled to £400 (equivalent to a 4% return) - the alternative finance return. X (whether an individual or a company) is not treated for the purposes of the Taxes Acts as entitled to any profits to which the agent is entitled and therefore any tax liability on the return received is limited to the actual amount received by X under the arrangement, not the full amount of the return made on the initial investment.

The £50 agency fee paid by Customer X is not an allowable deduction against the profit share return of £400.

The bank will account for the transaction in accordance with the relevant accounting standards, which are likely to regard the arrangements as a deposit of £10,000 on which it has paid a 4% per annum return to the customer. Under CTA09/SS509, the same view is taken for tax purposes - the bank has a debtor loan relationship of £10,000, and gets relief as a loan relationships debit for the £400 it pays. (The £50 agency fee would be taxable as a trade receipt). The £10,000 deposited by the customer will, as with any other deposit, become part of the bank’s general capital, and the investment return on that capital will form part of the bank’s taxable income. Thus the investment income of £600 will appear - and be taxable - somewhere in the bank’s accounts.

It has, however, been argued that a bank might regard itself as not being taxable on the £600, since it receives it as agent, not as principal. This is not HMRC’s view. The legislation provides that the principal (X, in this example) is not taxable on amounts to which the agent is entitled; this carries the clear implication that the agent (here, the bank M) is taxable on these amounts. In any case, taxation of the bank’s income, whether as trading income, as loan relationships credits, or other tax rules, will follow accounts prepared in accordance with GAAP. Nevertheless, in FA 2007 the matter was put beyond doubt by adding to the legislation that the agent is taxable on the income that it receives under the arrangement.