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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
, see all updates

Deemed loan relationships: shares with guaranteed returns: meaning of commercial rate of interest: simple commercial rate

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

The meaning of ‘the simple commercial rate’ is only relevant to times before 12 March 2008. Thereafter FA96/S103(3A) and (3B) have been repealed and the definition of ‘commercial rate of interest’ reverts to its normal meaning. This should have little practical effect as HMRC will continue to interpret the phrase ‘commercial rate of interest’ in the same manner as it interpreted ‘the simple commercial rate’ prior to the repeal of FA96/S103(3A) and (3B).

This change clarifies the fact that HMRC consider that the ‘commercial rate of interest’ would reflect the credit risk attaching to the borrowing party and that it should not be restricted to rates that would be offered by commercial deposit takers.

Commercial rate of interest: ‘the simple commercial rate’

The basic test in FA96/S103(3A) is whether the rate of return obtained is ‘reasonably comparable’ with the rate the company could have got by earning interest on the money it invested in the shares. Note there is no provision in S103(3A)(a) detailing what type of transaction or which counterparty should be used in determining the comparative rate, the only stipulation is that the rate should be arrived at in respect of the same amount of money (the interest that can be earned on money sometimes depends on how much money is involved).

The rate of interest which can be earned on money deposited or lent depends on a number of factors other than the amount. This will include the credit rating of the parties, and the term of the agreement, as well as prevailing interest rates at the time the transaction was entered into. It is HMRC’s view that the only sensible way to approach this question is to determine what rate could be obtained by the investing company by depositing the same amount of money with the issuing company for the same period as the actual avoidance scheme. Where the term of the scheme is not definite, there is usually an expected period for which it will last, and that is the period which should be used for comparison.

The rate earned by the investing company has to be ‘reasonably comparable’ with the rate that it could have earned from depositing the money. This allows for a range of rates, reflecting that in the commercial world the rate of interest agreed between the parties could itself fall within a range. It would normally be expected that the arrangements between an avoider and operator/facilitator of an avoidance scheme would be economically on arm’s length terms, so that if the rate was either far below or above a reasonable commercial rate, there are likely to be other elements to the arrangements which compensate the disadvantaged party.

The rate of interest that a company can earn on money depends on whether it is lending or depositing - the so called bid/offer spread. Thus a bank will generally charge a higher rate when lending money than it will offer when accepting deposits. It should not be accepted that a rate is not a commercial rate as defined on account solely of the bid/offer spread.

If a company argues that the rate it obtains in a case to which S91A or S91B would otherwise apply is not a commercial rate as defined in S103 (3A) (or, for times after 12 March 2008, not a ‘commercial rate of interest’), HMRC staff should seek the advice of CT & VAT (Financial Products Team).

Tax discounted rate

The second leg of the test is to cover the situation where the tax benefit expected to arise to the investing company is shared with the counterparty, so that the gross rate is less than the expected comparative rate. Imagine the equivalent deposit rate would be 5%. After tax, that would equate to 3.5% (after CT at 30%); so a rate anywhere between 3.5% and 5% would be treated as a commercial rate of interest under this part of the definition.