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HMRC internal manual

International Manual

Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 4 Part 2 - debt restructuring

Example 4 Part 2 - debt restructuring

Facts: For this part we assume that the loan did not create new funds in the UK, but was used to enable a new UK holding company to acquire shares in the existing UK sub-group. The reason a hybrid structure was not initially used was because it was anticipated that it would lead to a disallowance of interest deductions by reason of the arbitrage legislation. It was hoped that if the hybrid structure was not adopted until some time later, this would prevent the disallowance from taking effect.

Analysis: As above, Conditions A, B and D are met.

On the basis of the above facts, the period of time before the hybrid entity was involved does not indicate what would have happened in the absence of the qualifying scheme, because the original loan was part of a pre-planned series of transactions that included both the loan and the establishment of the hybrid. The loan was therefore part of the qualifying scheme from the date it was made.

The facts of this case are similar to those in Example 1 Part 1 and so the conclusion regarding Condition C is the same. A main purpose (if not the only main purpose) of the scheme involving the loan and the hybrid was to create a UK tax deduction that is not matched by any taxable receipt. The fact that this outcome was deferred for a period of time does not alter the conclusion, and so Condition C is met.

During the period of time before the hybrid entity was created, neither Rule A nor Rule B have any effect, because there is only one tax deduction and a corresponding taxable receipt. HM Revenue & Customs would therefore give clearance that notices would not be issued for this scheme in respect of accounting periods that fell wholly before the introduction of the hybrid entity.

For the accounting period in which the hybrid entity was set up and subsequent periods, Rule B applies to the whole of the interest on the loan. Because the UK tax advantage purpose relates to the whole of the interest paid on the loan, the company would need to disclaim all of the interest that falls within Rule B, and so the disclaim in F2A05/S24(14) to F2A05/S24(16) offers no advantage compared to Rule B in this example.