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HMRC internal manual

Corporate Finance Manual

Deemed loan relationships: shares accounted for as liabilities: returns ‘economically equivalent to interest’

‘Economically equivalent to interest’

In order for the special rules relating to shares accounted for as liabilities to apply, there must, as a result of the shareholding, be a return to the company holding the shares that is ‘economically equivalent to interest’. The return could be in the form of dividends, redemption or a combination of the two.

This is defined in legislation at CTA09/S521C(2) along the same lines as that used for the more general ‘disguised interest’ rules (refer to CFM42000).

There are three requirements.

Basic definition of interest (subsection (a))

The return must fit within a basic definition of interest. This basic definition of the meaning of interest is drawn from a number of the indicia commonly cited in cases on the meaning of interest (e.g. Euro Hotel (Belgravia) Limited 51TC293 and Bennett v Ogston 15TC374 - see CFM33030). This captures the familiar concepts that the return must be:

  • by reference to an amount, and
  • calculated by reference to the time value of money

Commercial rate of interest (subsection (b))

The return must be comparable to a commercial rate of interest. There are a couple of features to this condition that are worth noting.

The return must only be ‘comparable’. Consequently, the return does not have to be exactly the same as a commercial rate of interest. It therefore provides a range of interest rates within which a return could be ‘comparable’ to a commercial rate of interest.

In deciding whether an interest rate is comparable to a commercial rate of interest, you should assume that all factors are taken into account. A commercial rate of interest would therefore take into account the identity and creditworthiness of the counterparty. It could also include such features as the relationship between the two parties, the duration of the arrangement and the currency of the transaction(s).

Practical likelihood of the return (subsection (c))

The interest-like return must be predictable. There must be ‘no practical likelihood’ , when viewed at the ‘relevant time’ that the return will not be produced in accordance with the arrangement.

It is therefore not enough that an interest-like return results from the arrangements. If the return is the product of chance or could not have been reasonably anticipated at the outset of the arrangement, then it cannot be a return ‘economically equivalent to interest’.

In assessing whether there was ‘no practical likelihood’ that the return will not be produced in accordance with the arrangement you should ignore contingencies such as default outside of the control of the parties. This would include ignoring the possibility of default.

The ‘relevant time’ (S521C(3))

The ‘relevant time’ is defined for the purposes of S521C(2)(c), as being the later of the time when the company becomes party to the arrangements or the time when the return begins to be produced. It must therefore be clear at the outset that the return will be produced. Thus, although there is no express requirement for the arrangement to be ‘designed’ to produce the return, the return must be initially predictable.