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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.

In the link to the first example diagram below, UK Parent borrows €500m, which is used to buy shares issued by Financing CFC. This CFC then makes a loan of €500m to Trading CFC, which in turn repays its existing external debt of €500m. The arrangement has created two loans where before there was only one, with interest on one of the loans being sheltered by Financing CFC. It is very likely that the new UK tax deduction was taken into account in the decision to enter into this arrangement. Accordingly the arrangement will therefore have a main purpose of obtaining a tax advantage for UK Parent and so the loan to Trading CFC is not a QLR.

Use this link to view example diagram 1

In the link to the second example diagram below, a UK headed group acquires another, overseas headed group for £2bn. The acquisition vehicle is a new overseas intermediate holding company, Holding CFC. The UK parent borrows £1.4 billion, which together with cash reserves of £400m, are invested as equity in Financing CFC, an existing group treasury company. The terms of the new external borrowing provide £1.2bn to fund the acquisition of the Target Group and £200m to replace that group’s existing external borrowings (all held by non-UK resident companies). The UK parent also makes an equity investment of £400m in Holding CFC. Financing CFC lends Holding CFC £1.6bn, which together with its equity of £400m is used to fund the purchase of Target Group. On the day of the acquisition Financing CFC also makes loan totalling £200m to Target Group subsidiaries, to repay the existing external debt of £200m of that group.

NTFPs are generated by Financing CFC in respect of:

  • The proportion of the £1.6bn loan to Holding CFC, funded by the new UK external debt of £.12bn
  • The proportion of the £1.6bn loan to Holding CFC, funded by cash reserves of UK parent, and
  • The loans of £200m to the new overseas subsidiaries, funded by new external debt of £200m

Section 371IH (10) and (11) should not apply to prevent £1.2bn of the loan to Holding CFC being a QLR. This is because the arrangement is primarily concerned with the acquisition of the new group. These sections will also not have any effect for the balance of the loan of £1.6bn to Holding CFC. However the loans of £200m to Target Group overseas subsidiaries will require closer scrutiny as the choice of effectively replacing their external debt with debt ultimately funded by the UK is likely to indicate a main purpose of obtaining a UK tax advantage.

Use this link to view example diagram 2


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.