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HMRC internal manual

International Manual

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HM Revenue & Customs
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UK residents with foreign income or gains: corporation tax: Loan relationships: mark to market [APs ending before 1 January 2005]

A `dirty’ mark to market valuation of a loan relationship would reflect the interest which had accrued on the loan to the date of the valuation as well as any other factors affecting the value of the loan relationship. The interest itself is accounted for on a due and payable basis. The `dirty’ mark to market method was the authorised mark to market method under FA96/S85.

A `clean’ mark to market valuation does not reflect accrued interest but does reflect other factors which affect the value of the loan relationship. Interest is calculated on an accruals basis rather than on a due and payable basis.

A `clean’ mark to market method equates with the authorised mark to market method where the fair value does not reflect interest accrued and the credits and debits produced by the method correspond to the credits and debits produced by the authorised mark to market method of accounting.

It is necessary to observe the principle governing the allowance of tax credit relief mentioned at the beginning of INTM167160, namely that the foreign tax is credited against the UK tax which is computed by reference to the same income by reference to which the foreign tax is computed. That makes it necessary to identify how interest is reflected in the accounts when the mark to market method is used.

Example

A company has an accounting year end of 31 December. It buys a security on 1 May 2007 for £202,000 with a face value of £200,000. The security pays interest at 6 per cent per annum. The interest is paid twice yearly on 1 March and 1 September.

`Dirty’ Value

On 31 December 1997 4 months’ worth of interest has accrued and not been paid (£4,000). The dirty value on 31 December would be £204,000, assuming no other factors influenced the valuation. The company would show a credit of £2,000, ie closing value £204,000 minus cost £202,000, and would also show a credit for £6,000 interest due and payable on 1 September. The total credits would be £8,000.

Asset Account     Interest Account  
         
To purchase £202,000     To P&L £6,000 Interest received £6,000
To P&L £2,000 Closing value £204,000      

In practice we would take the view that the credits of £8,000 all represent interest, since the credit of £2,000 resulting from the closing valuation of the loan reflects the value of the interest that has accrued since the last payment of interest on 1 September. If the interest payments suffer foreign tax, credit relief (or a deduction under ICTA88/S811) may be allowed (subject to other restrictions such as ICTA88/S798 - INTM168000 onwards) for the appropriate proportions of that tax, that is, in the year ended 31 December 1997 four-sixths of the foreign tax deducted from the interest payment on 1 September 1997 and (if necessary on a provisional basis - see INTM167170) four-sixths of the foreign tax that will be deducted from the interest payment on 1 March 1998.

If the company claims credit relief on the due and payable basis (ie relief is claimed only in respect of the credit of £6,000) additional complications may arise, including the application of ICTA88/S807A (1) and (2) (INTM167210), and advice should be sought from Business International.

Suppose that in the above example the value of the security at 31 December 1997, because of an additional factor unrelated to the value of the accrued interest, was £203,000. The total credits to P&L for the accounting period would be £1,000 (instead of £2,000) from the valuation of the loan plus £6,000 for the interest received. For the purpose of allowing credit relief treat the former figure as reflecting a credit of £2,000 related to interest and a debit of £1,000 unrelated to interest, so that credit for foreign tax continues to be given by reference to a figure of £8,000 for interest.

`Clean’ Value

The company would adjust the opening purchase price to £200,000 to produce a `clean’ opening value and would retain the £200,000 clean value. Interest accrued for the eight months it owned the loan relationship during the accounting period would be £8,000.

Asset account       Interest Account
         
To bank for purchase £202,000 Adjust for purchased interest £2,000   Purchased interest £2,000 Interest received £6,000
  Closing value £200,000   To P&L £8,000 Interest accrued at 31.12.97 £4,000

Here the whole of the credit £8,000 comprises interest. Part of the credit reflects £4,000 interest accrued between 1 May and 1 September as part of the £6,000 interest received on 1 September. The other £4,000 reflects interest accrued from 1 September to 31 December as part of the £6,000 interest that will be received on 1 March 1998. If the interest payments suffer foreign tax, credit relief (or a deduction under ICTA88/S811) may be allowed (subject to other restrictions such as ICTA88/S798 - INTM168000 onwards) for the appropriate proportions of that tax, that is, in the year ended 31 December 1997 four-sixths of the foreign tax deducted from the interest payment on 1September 1997 and (if necessary on a provisional basis see INTM167170) four-sixths of the foreign tax that will be deducted from the interest payment on 1 March 1998.