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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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FA2010: risk transfer schemes: meaning of ‘risk transfer scheme’: conditions 2 and 3

The definition of a ‘risk transfer scheme’ is at CTA10/S937C and this states that in order for a scheme to be a ‘risk transfer scheme’ it must meet three conditions (Condition 1 is covered at CFM63340):

Condition 2

Condition 2 is that the result of the scheme is such that the group is not subject to the risk inherent in entering the scheme. So, applying this to the example at CFM63320, we can see that this condition is met as the result of the scheme is that despite having a prima facie exposure to the foreign currency risk of borrowing in yen, the group is not, ultimately, subject to that risk.

Condition 3

Condition 3 is that, if the operation of the tax system is ignored, then Condition 2 would not be met. In other words, it is the operation of the tax system that ensures that the group is not subject to the risk. Applying this to the example at CFM63320, we can see that it is the operation of the tax system that removes the group’s exposure to foreign exchange fluctuations on borrowing in yen; i.e. the fact that while changes in the value of the shareholding are on capital account (and hence not immediately tax effective), changes in the value of the yen borrowing are taxable/relievable as income.

Tax capacity assumption

When determining whether Condition 2 is met it is necessary to make the ‘tax capacity assumption’ as per CTA10/S937J.

This assumption is that whenever a company makes a scheme loss, the economic profits and losses must be calculated on the basis that any tax losses were fully brought into account for offset against an equal amount of profits chargeable to corporation tax.

This rule prevents companies that enter into risk transfer schemes from avoiding the rules by virtue of making tax losses in any particular year. In the absence of this rule the losses made by virtue of the scheme would not crystallise an economic benefit in the year in which they arose and therefore Condition 2 would not be met in that year.

For example, and referring to the example at CFM63320, if sterling depreciates against yen but there are no profits against which the loss of £13.9m on the borrowing can be offset the post-tax loss on the borrowing would be the full amount of £13.9m. This means that, despite the scheme, the company appears to be exposed to the foreign currency risk of borrowing in yen.

However, the company has increased its losses available for offset in future periods and so the benefit of the loss and, hence, the benefit of the scheme would just arise in a later accounting period.