INTM552490 - Hybrids: Hybrid transfers (Chapter 4): Examples: Simple repo transaction - no mismatch

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This example illustrates a straightforward repo transaction between related parties, in which both parties are treated as entering into a financing transaction for tax purposes. U Co benefits from a tax deduction for the funding cost on the in-substance secured loan and C Co is taxed on a corresponding amount of income.

Background

  • U Co is resident in the UK.
  • U Co holds a portfolio shareholding in I Co.
  • U Co sells its shares in I Co to a related company, C Co, for £100m, subject to an agreement (the Repo) that U Co will repurchase the shareholding after 3 months for £101m.
  • C Co is resident in Country CA.
  • No dividends are paid or payable on the I Co shares during this 3 month period.
  • U Co accounts for the transactions as a borrowing of £100m, secured on the shares in I Co, recognising a financing cost of £1m (being the excess of the repurchase cost of the shares). Under UK tax law U Co may deduct that £1m from its income for tax purposes.
  • The borrowing cost for U Co is at an effective annual rate of approximately 4% and is accepted as an arm’s length cost.
  • C Co also treats the repo as secured lending for tax purposes, and the in-substance interest of £1m is ordinary income of C Co in Country CA.

Analysis – Applying the tests in s259DA TIOPA 2010

Condition A: Is there a hybrid transfer arrangement in relation to an underlying instrument?

The agreement to sell I Co shares for £100m and repurchase them after 3 months for £101m is a repo in the ordinary sense of the term as used in the context of financial transactions. The Repo is a hybrid transfer arrangement as defined at s259DB(2) only if it provides for, or relates to, the transfer of a financial instrument and

  • the dual treatment condition is met, or
  • a substitute payment could be made

The I Co shares are a financial instrument, as defined at s259N. The Repo is, therefore, an arrangement providing for the transfer of a financial instrument.

The dual treatment condition is met if, for tax purposes -

  • one person regards the arrangement as equivalent to a transaction for the lending of money at interest, and a payment or quasi-payment made under or in connection with that arrangement is treated accordingly, and
  • another person does not treat that payment or quasi-payment as equivalent to a transaction for the lending of money at interest.

On the facts given above, the dual treatment condition is not met because both U Co and C Co treat the payment of £1m under the Repo as a transaction under an arrangement that is equivalent to the lending of money at interest.

No dividends are paid or payable to C Co during the 3 months it holds the shares. Assuming that the Repo does not contain any provision to make a substitute payment (for example, because the period covered does not include a record date for I Co shares), no substitute payment could be made by C Co to U Co.

Condition A is not satisfied, as the dual treatment condition is not met and there cannot be a substitute payment. It is not necessary to consider the remaining conditions at s259DB.

Conclusion

The conditions at s259DB(2) are not satisfied, so there is no hybrid transfer arrangement and there can be no counteraction under Chapter 4.