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HMRC internal manual

Corporate Finance Manual

Derivative contracts: tax avoidance: derivative contracts with non-residents

Interest-like payments under contracts with non-residents

CTA09/S696 provides that in certain circumstances net debits equivalent to interest paid to overseas residents shall not be deductible. The rule is designed to ensure that companies do not get a deduction for interest-like payments under a derivative contract in circumstances where, had they simply been paying interest on a loan, they would have to deduct tax.

The basic premise of CTA09/S696 is that it applies whenever a UK company (‘A’) is party to a derivative contract with a non-resident (‘NR’) under which amounts of notional interest - amounts calculated by applying a fixed or floating rate of interest to a notional principal amount - are paid or received. But this is subject to widely-applicable exceptions under CTA09/S697, and in practice very few contracts will come within the provision.

When the rule applies no ‘excluded debits’ arising on the derivative contract are brought into account.

Excluded debits are the excess of notional interest payments made by A to NR over the notional interest payments made by NR to A. See below for an example.

The rule does not apply in the following circumstances:


  • the UK company (‘A’) party to the derivative contract is a bank, building society, financial trader or clearing house, and
  • it holds the contract solely for the purposes of a trade or part of a trade carried on by it in the UK, and
  • it is party to the contract as a principal.

Where the non-resident (‘NR’) holds the contract solely for the purposes of a trade (or part of a trade) carried on in the UK through a branch or agency, and the non-resident is party to the contract as principal.

Where the other party to the contract is a resident of a country with which the UK has a double taxation agreement and that agreement contains an interest article. The effect of this is to exempt residents of most normal rate countries whilst still catching transactions with tax havens. Business International will advise on specific double taxation agreements and the operation of S696.

‘Bank’ and ‘financial trader’ are defined at CTA09/S710 and ‘recognised clearing house’ is defined at CTA09/S697(6). The definition of ‘financial trader’ at CTA09/S710 includes a person who is approved by the Commissioners for the purposes of this section.

To obtain the Commissioners’ approval, a company must demonstrate that:

  • it is carrying on a trade, the profits or losses of which would fall to be dealt with trading profits under CTA09/PT3.
  • this trade includes the provision of derivative contracts (within the meaning of CT09/PT7) to counterparties in the normal course of trade
  • this part of the trade, on its own, satisfies the test in IRC v Livingston (11 TC 538) - ie, the operations involved must be of the same kind and carried on in the same way as those which are characteristic of ordinary trading in the line of business in which the venture is made

Where a company enters into derivative contracts with associated companies, then it will be easier for it to demonstrate that the third part of this test is satisfied if it also enters into derivative contracts to a significant extent with third parties on the same terms. Failing this, a company will need to produce evidence that it is conducting its operations with its associated customers in the same way as if they had been unconnected. Relevant considerations will include:

  • the type and range of contracts into which it enters
  • the management of market risk
  • the assessment of credit risk
  • the level of reward obtained in terms of fees or spread





BAI (Financial Products Team) deal with any questions arising from the Commissioners’ approval.


Simtring plc (a UK company which is not a bank, building society or financial trader) enters into an interest-rate swap with an unconnected company resident in a territory with which the UK does not have a double taxation treaty. Under the agreement it receives fixed-rate payments on a notional principal of £10m at 6% and makes payments computed on the same notional sum at LIBOR plus 2%. The terms are at arm’s length.

During the accounting period the interest payments which the company makes periodically under the swap exceed the periodic payments it receives by £100,000.

The £100,000 excess of the debits over the credits is a relevant debit and is disallowed by S696. The purpose for which the UK company was a party to the swap is irrelevant for the purposes of S696 - there is no requirement for any tax avoidance purpose.