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HMRC internal manual

Corporate Finance Manual

Other tax rules on corporate debt: group mismatch schemes: tax capacity: example

Company A and company B are within the same group. Company A issues a £100 million zero coupon bond to company B that can be converted into ordinary shares in company A.

Company A accounts for the bond in accordance with FRS 102 and splits the bond into an equity element valued at £10 million and a debt element of £90 million.

Company B accounts also using FRS 102, but because it is the holder of the financial asset it does not bifurcate the instrument for accounting purposes and so accounts for the debt element at £100 million. Company B would measure the instrument at fair value in its accounts. For tax purposes, however, company B would be required to apply an amortised cost basis of accounting (see CFM35170).

Company A claims a finance charge of £10 million over the life of the bond whereas company B brings in no equivalent credits.

The scheme - previously caught by section CTA09/S418 - is a group mismatch scheme (GMS) because at the point it was entered into it was practically certain to produce a relevant tax advantage. CTA09/S418 was repealed with the introduction of the GMS rules.

In this example, the relevant tax advantage would be the £10m brought to account by company A over the life of the bond and it would be these debits that the GMS rules would act on to not bring them into account.

If the convertible loan carried a low rate of interest that company A and company B brought into account symmetrically (but with company A still claiming additional deductions) the interest debits would form part of a single finance charge, while the credits would be the creditor’s CTA09/Part 5 profits. Both amounts would be scheme losses and profits and would also be disregarded.