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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Other tax rules on corporate finance: stock loans: anti-avoidance: deemed interest on cash collateral

Anti-avoidance provisions for deeming interest on cash collateral

The lender of securities in a stock lending arrangement will usually require collateral from the borrower in the stock lending arrangement in the form of other securities or cash, to guard against the default of the borrower in respect of the original stock loan.

In a normal commercial stock loan manufactured payments are made by the stock lender to return any dividends or interest income received on securities while held as collateral to the stock borrower. Similarly, in a normal commercial stock loan the lender is required to put any cash collateral on deposit and the interest arising is paid over to the borrower.

Anti-avoidance rules at ITA07/S596 and CTA10/S812 (see CFM74160) counter avoidance schemes where stock lending arrangements are entered into without any provision for manufactured payments on securities, including the securities held as collateral, by invoking deemed manufactured payments in these circumstances.

Further avoidance schemes sought to sidestep ICTA88/S736B. These were open to challenge under the ‘shares as debt’ rules (CFM45000). In addition, ICTA88/S736C was introduced for stock lending arrangements entered into on or after 5 December 2005. These schemes involve the stock borrower acquiring securities that will pay dividends that are either non-taxable or taxable at a lower rate than interest income and supplying collateral wholly in cash, on which no interest is payable or interest is returned at less than a reasonably comparable deposit rate. The effect of this is that the original stock loan borrower has substituted a non taxable (or lowly taxed) dividend income stream arising from the securities borrowed, in place of an existing taxable income stream of interest from cash deposits.

The ‘shares as debt’ rules and ICTA88/S736C were repealed for companies with effect from 22 April 2009 following the introduction of the disguised interest rules in CTA09/PT6/CH2A (CFM42000). ICTA88/S736C has been rewritten for income tax purposes in ITA07/S597-S598.

ITA07/S597 provides that where:

  • ITA07/S596 applies to a borrower in a stock lending arrangement (no manufactured payments made)
  • cash collateral is payable to the lender as security for the stock borrowed
  • the stock lending arrangement is designed to produce a return to the borrower that equates to investment of money at interest
  • the main purpose, or one or the main purposes of the stock loan is to obtain a tax advantage

then the borrower in the stock loan arrangement is deemed to receive an amount or interest on the cash collateral calculated in accordance with subsections (3) to (7).

The deemed interest payable to the borrower is at a rate reasonably comparable to a rate the borrower could obtain by placing the cash collateral on deposit for the interest period and is reduced (but not below nil) by any interest which the borrower actually receives in respect of the collateral for the interest period. Small amounts of interest are often paid in these arrangements to top up the income cash flows from dividends retained by the stock loan borrower to commercial levels of return.

Where the amount of cash collateral provided is variable, interest is computed on the highest amount of cash collateral provided at any time during the period of the stock loan.

The effect of ITA07/S597 is to put the stock loan borrower back in the same economic position as it would be if the usual commercial stock loan arrangements for rebate of interest on cash collateral had been followed. The borrower receives a taxable income stream of interest on cash at a rate comparable to deposit rates for the duration of the stock loan.