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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Deemed loan relationships: shares with guaranteed returns: non-qualifying shares: the redemption return condition

CTA09/S529

This guidance applies to companies that hold shares up to 21 April 2009

CTA09/S529 sets out the redemption return condition for S526. This caters for certain cases where a share is designed to produce an interest-like return. The return can be in any form (other than purely increases in value catered for by CTA09/S527), but is most likely to be fixed rate dividends on redeemable preference shares. But because such shares are commonly used for genuine commercial financing arrangements not involving tax avoidance, the redemption return condition has a number of filters described at CFM45210.

CTA09/S529 provides that the redemption return condition is that the share is:

  • redeemable,
  • designed to produce a return which equates, in substance, to the return on an investment of money at a commercial rate of interest (see CFM45090), and
  • not an excepted share (see CFM45210).

For these purposes, a share is regarded as redeemable only if it is redeemable as a result of its terms of issue, or by virtue of any collateral agreements, arrangements or understandings, which

  • require redemption,
  • entitle the holder to require redemption, or
  • entitle the issuer to redeem.

In other words, there have to be specific terms or agreements under which the shares can or will be redeemed.

Example

Company A wishes to invest spare cash and unconnected company B wishes to borrow money for a period of one year. As company B has tax losses, it does not need the tax relief available for paying interest on its borrowings, and so the two companies agree to share the benefit of B’s tax losses to mutual benefit. Instead of company A simply lending its cash to company B at, say 5%, they agree that company A will subscribe for fixed rate preference shares which will redeem in a year’s time. The dividends are fixed at 4.5%, reflecting the fact that company A will not be taxed on the dividends because of ICTA88/S208 (thus sharing the tax advantage with company B). Effectively, the two companies are sharing the benefit of company B’s losses.

Company A will be holding the shares for an unallowable purpose, since it is seeking a tax advantage in the form of non-taxable income, so the shares are not ‘excepted shares’. Therefore S529 will apply to treat the shares as a creditor loan relationship in the hands of company A. The result is that Company A will be effectively taxed on the 4.5% ‘interest’ it earns on the cash it invested in the shares.

Company B will not be affected by S526.

Extended definition of redeemable - 22 March 2006

FA 2006 extended the definition of redeemable. A share is also redeemable where there are arrangements which will or might entitle the investing company to qualifying redemption amounts.

This extension has effect in relation to shares held by a company on or after 12 May 2006 in any case where the share is redeemable for the purposes of CTA09/S529 as a result of any of the arrangements mentioned above and the arrangements were entered into after the company acquired the shares. However, in relation to accounting periods beginning before 12 May 2006, the amounts to be brought into account for loan relationship purposes as a result of this amendment are limited to those amounts that relate to any time on or after that date.

In any other case, the FA 2006 amendment has effect in relation to shares held by a company on or after 22 March 2006. However, in relation to accounting periods beginning before 22 March 2006, the amounts to be brought into account for loan relationships purposes as a result of this amendment are limited to those amounts that relate to any time on or after that date.

S529(7) provides that ‘arrangements’ include any agreement or understanding regardless of whether they are legally enforceable or form part of the terms of issue of the share. ‘Qualifying redemption amounts’ are defined as amounts which, when taken together, are the same, or are substantially the same, as an amount that might be payable on the redemption of the share.

Extended definition of redeemable - 12 March 2008

FA 2008 further extended the definition of redeemable. From that date a share will be treated as redeemable if it is reasonable to assume that the investing company will or might become entitled to qualifying redemption amounts, even if it is not certain that the company is party to any arrangements that will give rise to an entitlement to such amounts.

This is intended to catch cases where although there is no paper trail evidencing the intention that the investing company will divest itself of the shares or liquidate the company, it is obvious that the company can do this at any time so as to recoup its initial investment.

It does not catch every case where an investing company holds shares. It must, as a minimum condition, be reasonable to assume that in the future the share will or might be sold or liquidated by the investing company. There may be regulatory reasons why the shares held by a company could not be sold, or the company in which the investing company holds the shares may carry on activities that form part of the core activities of the group such that it is unreasonable to assume that the shares could be sold without a wider disposal of those core activities by higher tier shareholders.

Designed to produce a return

In order for CTA09/S529 to apply, the share must be designed to produce a return which equates, in substance, to the return on an investment of money at a commercial rate of interest. Thus contingent returns cannot be caught. As with the increasing value condition, the redemption return condition will not apply to ordinary shares issued by genuine trading companies (including normal commercial finance leasing companies) because if there are a variety of transactions with receipts and expenses of differing amounts (and tax allowances which affect the overall commercial return) it is only going to be by chance that the value of the shares increases in an interest-like way.