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HMRC internal manual

International Manual

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Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 1 Part 2 - inward investment

Example 1 Part 2 - inward investment

Facts: As with part 1, except that UK Hold Co has used only half of the proceeds of the loan to purchase from Code A Hold Co the shares in UK Operating Co. The other half has been used to invest in additional premises for use in UK Operating Co’s business operations.

Analysis: For UK Hold Co, conditions A and B are satisfied as in part 1. The question of condition C is, however, less straightforward than in part 1. In this example, the effect of the scheme is twofold. As in Part A, the loan has replaced an equity investment by Code A Hold Co into the UK group. However, in this example, the loan has also funded the purchase of business premises. Overall, the loan has given 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 there are two main purposes. One of the main purposes of the scheme is to achieve a UK tax deduction unmatched by a taxable receipt, another main purpose is to fund the purchase of business premises. Condition C only requires that there is at least one main UK tax advantage purpose. The condition is again satisfied.

However, UK Hold Co may want to consider making a disclaimer. If, as suggested in the above analysis, the funding of the premises is not affected by the existence of the scheme, it can be considered that obtaining a UK deduction for that part of the interest cost was not one of the main purposes. If so, the company can disclaim half the interest deduction (relating to the equity replacement) and thus counteract the effect of the main purpose in condition C. The other half of the interest deduction will not therefore be caught by this legislation and will be allowed as a deduction, provided other UK interest deduction rules, such as thin capitalisation, are satisfied.