Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 1 Part 1 - inward investment
Example 1 Part 1 - inward investment
There are three parts to this example. Part 1 shows a scheme that is caught, part 2 shows a scheme where a disclaimer can be made and part 3 shows a scheme that is not caught. The underlying structure is the same for each part.
|A/c’s entry||Tax (UK)||Tax (Code A)|
|Code A Hold co||Income 10M||-||-|
|UK Hold co||Expense 10M||(10M)||-|
|UK Op Co||Income 20M||20M||-|
Facts: Code A Hold Co has made a loan to a new UK Hold Co which has in turn used the funds to purchase from Code A Hold Co all of the shares in UK Operating Co that Code A Hold Co used to own directly.
Analysis: Looking at UK Hold Co, it is necessary to consider the conditions set out in F2A05/S24 to see if the legislation is applicable.
Condition A: Is there a qualifying scheme involving UK Hold Co?
There is a scheme in this case which involves UK Hold Co. It starts with the loan from Code A Hold Co and ends with a payment by UK Hold Co to Code A Hold Co for the shares in UK Operating Co. The scheme is also a qualifying one because it includes a hybrid - in this case UK Hold Co is recognised in the UK as a person for UK tax purposes but under Code A, it is recognised as a branch of Code A Hold Co. It does not matter that the application of Code A nets off or fails to recognise the loan.
Condition B: Does UK Hold Co get a deduction or set off for UK tax purposes under the scheme?
Yes, in this example it is the deduction for the loan interest paid to Code A Hold Co.
Condition C: Is it one of the main purposes of the scheme to achieve a UK tax advantage?
This will depend on the facts and circumstances. It is however important to note that it is the purpose of the scheme (which is a qualifying scheme) that matters and not just the purpose of any transactions that make up the scheme. Thus whilst in this example there is only one transaction (the loan) which directly gives rise to a UK tax advantage, it is necessary to consider the purpose of the scheme as a whole and, in particular, the inclusion of a hybrid (which makes it a qualifying scheme). In this example, the effect of the scheme is that the loan has wholly replaced an equity investment by Code A Hold Co into the UK group, thereby giving rise to a UK tax deduction - and one which is not matched by a taxable receipt. What has to be considered is whether one of the main purposes of the scheme is to obtain that UK tax deduction. Following the above analysis, it is considered that the only purpose of the scheme is to achieve a UK tax deduction unmatched by a taxable receipt. Condition C is therefore satisfied.
Condition D: Is this intended advantage more than a minimal?
Yes, the advantage is a reduction of £10M and is therefore more than £50,000.
As conditions A to D are satisfied, we can assume that the Commissioners of HM Revenue & Customs will issue a notice if it is to have an effect. We must therefore consider what the effect of the deductions rules will be.
Rule A applies where a deduction is allowed more than once. This is not the situation here as Code A does not see the transaction giving rise to the deduction at all.
Rule B applies to a deduction to the extent that the payee is not taxed. This does apply. Again, it is immaterial that Code A does not recognise the receipt for tax purposes. All that matters is that the payee is not liable to tax on that receipt. Rule B will apply to deny all the deduction of interest (£10M).
Disclaimer: Finally, can UK Hold Co make a disclaimer to “switch off” the effects of the legislation?
In this example, because the sole purpose of the scheme is to achieve the UK tax deduction, the only way UK Hold Co could avoid the application of the rules would be by disclaiming the entire deduction.