IFM40770 - Treatment of certain payments: deeply discounted securities

FA22/SCH2/PARA51

Where a company either issues debt at a discount or issues debt which is redeemable at a premium, the resulting debit will accrue over the life of the loan and be relieved for taxation accordingly. This can create a mismatch where the lender is outside the loan relationship regime (for example, if they are an individual) because they will not recognise the corresponding credit until the discount or premium is actually received. There is a risk that this mismatch could be exploited if borrower and lender are connected.

CTA09/S409 was introduced to prevent such manipulation. The section works by deferring taxation relief for debits arising on deeply discounted securities (DDS) until the security is redeemed rather than allowing relief as the debit accrues over the life of the loan if the debtor is a close company and there is a specified relationship between it and the creditor. CFM37200 has further guidance on this.

This rule can create an issue for a QAHC where it is funded by shareholder debt with a premium payable on redemption to reflect the underlying profit of the QAHC. Such an instrument will typically qualify as a DDS. A QAHC may be a close company and if it is CTA09/S409 would be engaged and only relieve debits when the security is redeemed rather than when they accrue. As with the application of the late paid interest rules (IFM40760) this can cause an issue where the accruing debits are matched with credits on the underlying investment.

PARA 51 provides for this by disapplying CTA09/S409 to a ‘qualifying debit’. A debit in respect of a DDS will be a qualifying debit provided it meets all of the following conditions:

  • it relates to the discount that accrues on the deeply discounted security;
  • the QAHC is party to that security for the purpose of its QAHC ring fence business;
  • the discount to which the debit relates is referable to an accounting period during which the QAHC was a QAHC.
Example

A QAHC issues a deeply discounted security to its shareholders for the purpose of its QAHC ring fence business. A discount of £50 accrues on the security in the first accounting period. The QAHC then leaves the QAHC regime and further discounts of £50 accrue across each of the next two accounting periods. The security is then redeemed with a premium of £150 payable on redemption.

The £50 discount that accrues in the first accounting period will be relieved on the accruals basis because PARA 51 will engage to disapply CTA09/S409. The £50 discounts in the second and third accounting periods (£100 in total) will be relieved on the paid basis because PARA 51 cannot apply to debits which relate to an accounting period when the QAHC was not a QAHC. In total, the QAHC can claim corporation tax relief of £150 which matches the discounts shown in the accounts.