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HMRC internal manual

International Manual

HM Revenue & Customs
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Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 4 Part 1 - debt restructuring

Example 4 Part 1 - debt restructuring

A foreign owned group lends money to a UK sub-group without the use of any hybrid entity or instrument, and maintains its debt within the terms of a thin capitalisation agreement. Several years later it restructures its debt using a scheme involving a hybrid entity, with the result that the interest receipt is no longer taxable in the parent company’s jurisdiction. The restructuring does not alter the amount of debt in the UK or its terms or conditions.

Part 1

Facts: For this part we assume that when the original loan was made there was no plan or intention to make use of a hybrid structure at any future time, and so the decision to incur the original interest expense was not influenced by the arbitrage opportunity.

Analysis: Following the creation of the arbitrage scheme under the restructuring, Condition A is met. Conditions B and D are met because of the deductions for interest paid on the loan, which now represents part of a qualifying scheme.

The question to be addressed in considering Condition C is whether the same UK tax deductions would have arisen if the interest receipts had been subject to tax in the other jurisdiction. In this case, it appears that they would, because the same deductions did arise in a period when the interest was taxed. At that time the use of a hybrid entity had not been anticipated, and so did not influence the decision to make the loan.

Therefore Condition C is not met and the legislation does not apply.