Other tax rules on corporate finance: structured finance: conditions for section 758
The conditions for a simple structured finance case
The conditions for section 758 to apply are set out in section 758(2) as follows:
- Under the arrangements one person (the ‘borrower’) receives in any period money (or some other asset, called the ‘advance’) from another person (the ‘lender’),
- the borrower records in its accounts in that period, and in accordance with GAAP, a financial liability in respect of the advance,
- the borrower, or a person connected with the borrower, disposes of an asset, which is labelled the ‘security’, to or for the benefit of the lender, or to a person connected with the lender
- as a result of that transfer the lender is entitled to receive payments in respect of the security,
- in accordance with GAAP the payments reduce the amount of the financial liability recorded in the borrower’s accounts.
The conditions in section 758 seek to identify the essential characteristics of the schemes being targeted, namely that in substance they are lending transactions accounted for as such and secured on certain assets that repay the loan.
‘Financial liability’ takes its accounting meaning. But for the rules to apply it is not enough that the transaction is accounted for as a financial liability. The additional conditions make it clear that the arrangements must also have the standard characteristics of a secured loan to come within the rules.
The legislation refers to the borrower receiving under the arrangement either money or some ‘other asset’. This is to ensure that the rules cannot be avoided by the borrower receiving some asset that can be readily converted into cash.
The ‘security’ may be provided either directly by the borrower or by a person connected with him. Similarly it may be given either directly to the lender or to a person connected with him. This is to ensure that the rules apply even if the transaction is fragmented amongst members of a single economic entity. Although normally the security would be transferred back to the borrower at the end of the arrangements, this is not necessarily the case if, for instance, the asset is a wasting one that will be wholly depleted in repayment of the ‘loan’.