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HMRC internal manual

International Manual

Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 5 Part 2 - dividends

Example 5 Part 2 - dividends

Facts: The UK sub-group is funded largely by equity representing retained profits. The combined effect of the loan and dividend is to replace a proportion of the UK equity by debt, and the scheme creates no new funds for investment. The dividend represents several years’ worth of profits and so is exceptional by reference to the UK sub-group’s usual policy. The profits are retained in the parent company and for the most part are not paid on to the group’s ultimate shareholders. The loan has a 10 year repayment term.

Analysis: Different fact patterns will lead to different conclusions in such cases, but the above facts suggest either that the scheme did not have a main purpose to deal with a short term cashflow difficulty, or that this purpose did not extend to the whole of the finance provided by the scheme. Therefore it appears that a main purpose of the scheme was to increase UK tax deductions for interest. Therefore Condition C would be met in such a case and Rule A would deny the interest deductions because of the existence of the double deduction.

It is a question of fact and circumstance whether the whole of the loan relates to the scheme’s UK tax advantage purpose. It may be possible to identify part of the loan that does not relate to this purpose, but which serves the same sort of function as the loan described in the first part of this example. If so, the company could disclaim interest deductions that arise from the part of the loan that corresponds to the tax purpose of the scheme, but not those that arise from the commercial purpose, in order to prevent further disallowance under Rule A.