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HMRC internal manual

International Manual

Controlled Foreign Companies: The CFC Charge Gateway Chapter 9 - Exemptions for profits from Qualifying Loan Relationships: What is Excluded from the definition of a Qualifying Loan Relationship: Section 371IH(5)(6)&(7)

Section 371IH(5)

TIOPA10/Part 9A/S371IH(5) is an anti-avoidance rule. It excludes claims under Chapter 9 where there is an arrangement having a main purpose of securing that the ultimate debtor provides a loan or funds that give a return that is economically equivalent to interest to someone else. The rule works by preventing a loan relationship from being a qualifying loan relationship (“QLR” - INTM217000) where it is an arrangement, or is connected to an arrangement, the main purpose or one of the main purposes of which is for the ultimate debtor to provide, directly or indirectly, funding for a loan relationship, or a transaction that is economically equivalent to the provision of a loan relationship, to another person.

One of the intentions of the ultimate debtor rule is to ensure that only loans that are in substance qualifying loan relationships actually benefit from the Chapter 9 exemptions. Section 371IH(5) supplements the ultimate debtor rule and should therefore have limited application if the ultimate debtor rule is working as intended. It is targeted at artificial arrangements designed to conceal the true identity of the ultimate debtor, or arrangements structured so as to prevent the funding to an ultimate debtor being a loan relationship (an arrangement for example where the funding to the ultimate debtor is structured by way of a loan relationship to an intermediary group company, but then structured as funding which isn’t a loan relationship to the ultimate debtor).


Example 1

A loan is made by the CFC to another non-UK resident company and that company arranges for a loan to be made (using the funds from the first loan) by another person to a UK resident connected with the CFC. The CFC is asked only to make the loan to the non-UK resident company and is not informed that the loan will be used to fund another loan. The main purpose of the arragement is for the CFC to make a loan to the UK resident connected company, even though the CFC is not informed about the ultimate borrower. The loan by the CFC is not a QLR.


Example 2

CFC A lends to CFC B which uses the funds to pay a dividend. CFC B uses the cash generated from its activities to lends to a UK resident person (rather than using the cash to fund the dividend). Absent an arragement and looking just at transactions in isloation the purpose of the loan from A to B is not to provide funds for lending but to fund a dividend and so would be a qualifying loan. However if a main purpose of the arrangement was to provide a loan from CFC A to a UK resident connected person then section 371IH (5) will apply to treat the loan to B an non-qualifying.


Section 371IH(6) & (7)

As with the ultimate debtor rule, the anti avoidance rule in section 371IH(5) works in a different way for banking and/or insurance groups. Section 371IH(6) disapplies subsection 5 in respect of a loan made by a CFC to another group company whose main business is banking or insurance and the loan or arrangement is made in the ordinary course of that business. This recognises that a banking or insurance company will in most cases be providing funding that is used to make a loan to another person, or provide funds in a way that the return on the provision of funds will be calculated in a similar way to that for a loan.

This relaxation of section 371IH(5) for banking and insurance CFCs does however open up the possibility for section 371IH(6) to be exploited by banking and insurance groups. To deal with this section 371IH(7) prevents a loan from a CFC being a QLR if the bank or insurance company which is the ultimate debtor uses the loan to fund a loan or other arrangement - as set out in section 371IH (5)(a) or (b) - to create a tax advantage for the ultimate debtor.