IFM40640 - Other tax issues: amortised cost basis of accounting

FA22/SCH2/PARA39

The accounting treatment of financial assets and liabilities held by a QAHC will depend on how they are classified. This will typically be one of Amortised Cost (AC), Fair Value through Other Comprehensive Income (FVTOCI) or Fair Value through Profit or Loss (FVTPL).

Although the tax treatment will often follow the accounting treatment, there are exceptions to this. CTA09/S349 is one such exception and mandates that all financial instruments made between connected companies must be treated for corporation tax purposes as held at AC regardless of how they are recognised in the accounts. CFM35170 has further guidance on this.

S349 can cause a mismatch where a connected company lends money to a QAHC which the QAHC then on-lends to a third party. This will typically be the case where a corporate is placed between the fund and QAHC for use as an aggregating vehicle. The QAHC should have enough latitude in its accounting treatment to ensure the loan liability from the corporate and the loan asset to the third party are classified the same in the accounts. If each instrument was held at FVTPL then fair value movements on the liability should be matched with a corresponding, opposite movement on the asset.

The tax treatment would not follow the accounts, however, with the debt liability determined on an AC basis (because the creditor is a connected company) rather than FVTPL. The debt asset would continue to be recognised at FVTPL for tax resulting in a tax mismatch because fair value movements on the asset would be brought into account in full.

PARA 39 prevents such a mismatch and disapplies S349 to a debtor relationship of a QAHC to the extent that relationship is used to fund a creditor relationship of the QAHC which is:

  • Recognised in the accounts at FVTPL, and
  • Not required to be recognised for corporation tax purposes at AC.

On the example above, the tax treatment of the debt liability would now follow the accounts meaning fair value movements would continue to be brought into account where they could be matched with movements on the debt asset.

If the example was altered so that the QAHC now on-lent the money to a connected company, PARA 39 could not apply because the debt asset would now be treated as held at AC for tax purposes. PARA 39 does not need to engage here because there is no tax mismatch. Both debt asset and debt liability are treated as held at AC.

PARA 39 cannot alter the tax treatment of a connected companies creditor relationship.

Example

A QAHC borrows £100 from a connected company and on-lends £75 of this to an unconnected party. Both loan liability and loan asset are recognised in the accounts at FVTPL.

PARA 39 disapplies S349 to the extent the liability is used to fund a creditor relationship. Here, £75 of the loan liability will be recognised for tax at FVTPL and £25 will be recognised for tax at AC.