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HMRC internal manual

Corporate Finance Manual

Other tax rules on corporate finance: structured finance: partnership finance charges

Deduction for finance charge

The aim of the structured finance rules is to ensure that the tax system is neutral as between borrowing under a structured finance arrangement and other forms of borrowing. But the rules would not on their own achieve that result because, for there to be neutrality, the borrower would need to obtain relief for its costs of funding. As a matter of legal form the borrower is not party to a loan and does not pay interest, so it might be difficult for it to obtain relief for the finance charge, which equates in substance to interest, that is shown in its accounts.

Accordingly section 766 (1) to (3) deals with the relief for the finance charge in a Condition A case, while section 769 (4) deals with the relief in a Condition B case. This is done in a similar manner to section 762. In particular any finance charge that in accordance with GAAP is recorded in the accounts of the ‘borrower partnership’ will be treated as interest on a loan.

Section 766 (4) provides that references to the accounts of the borrower partnership in a Condition A case are to include the accounts of any transferor partner, while section 769 (4) provides that in Condition B cases the references include the accounts of any relevant member, that is, any person who was a member of the borrower partnership immediately before the arrangement apart from the lender itself.

In the income tax case the finance charge is treated as interest payable by the transferor partner and in the corporation tax case the advance is treated for the purposes of sections 385-390 CTA 2009 as debtor loan relationship of the borrower partnership and the finance charge as interest payable by the transferor partner.

The relevance of treating the finance charge as interest under a loan relationship is that the amount will become subject, where appropriate, to provisions in the loan relationships code which apply to interest such the late interest rule (CFM35800) and unallowable purposes (CFM38100). In order to give a rule as to the time of payment of the interest, section 766 (5) treats the payments received by the lender under the structured finance arrangements as divided into principal and interest with the interest element of each payment treated as paid when the payment is received by the lender.

In a Condition A case, the reversal of the relevant effect in the case of the transferor partner by section 765 (2) (that is, restoring the tax charge on 100% of the alienated income) has no consequences for allocating that partner’s share of the finance charge. In particular the transferor partner will potentially get a deduction for the actual finance charge shown in its accounts. In a Condition B case that is true for all partners other than the lender. This exclusion for the lender is to ensure that in Condition B cases the lender does not obtain an increased share of the finance charge based on its increased profit share.