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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(10)&(11)

TIOPA10/Part 9A/S371IH(10) and (11) prevent a loan from being a qualifying loan relationship (“QLR” - INTM217000) where third party debt of a non-UK resident group company is repaid (in whole or in part), and effectively replaced with new UK debt under or in connection with an arrangement the main purpose or one of the main purposes of which is to obtain a tax advantage for any person. The rule catches arrangements that give rise to an increase in debt in the UK whether provided by a third party or to a non UK resident connected persons. If a loan is made to a UK resident group company, which in turn lends to another UK resident group company then the UK to UK element is ignored.

The test of purpose in subsection (10) must be applied to the whole of the arrangement, not just to particular loans which form part of the arrangement. In particular, it should apply even if the CFC itself has no tax purpose in making its loan. The fact that the existing external debt was used for a commercial purpose may have little bearing on what the main purpose of an arrangement is.

The transactions detailed in subsection 371IH(10), namely the loan to the UK resident connected company, the funding of the CFC and the use of those funds to enable a non-UK resident group company to repay external debt must occur under the same arrangement. Thus the raising of UK debt should not be regarded as “indirectly connected” to a later funding of an overseas subsidiary to repay external debt unless there is a link between the two funding flows. Where a UK headed group raises debt in the UK, for example in the context of an acquisition transaction, the UK group may need to raise funds to repay debt of the target group. The arrangements by which this additional funding is structured may require closer scrutiny.

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Whether or not there is an arrangement with a main purpose to obtain a tax advantage will be a question of fact and it is difficult to generalise the circumstances in which the repayment of non UK external debt in as the circumstances outlined in the above example might constitute such an arrangement as there may be a number of factors involved in the refinancing. Some of the circumstances which may need to be taken into account would include:

  • Whether aligning the banking relationships of the target group with those of the acquisition group of necessity required the overseas external debt to be replaced with UK external debt.
  • Whether the existing external debt of the target group is part of cash pool arrangements that can no longer continue under the banking arrangements of the acquiring group.
  • Any banking covenants that have to be maintained as conditions of new debt being taken on in the UK part of the group.