Finance (No. 2) Act 2010 Explanatory Notes

Background Note

11.The corporation tax rules that apply to loan relationships and derivative contracts are based on the principle that amounts brought into account for tax purposes as credits and debits under those rules are those that, in accordance with GAAP, are recognised in determining a company’s profit or loss for the period.

12.In certain circumstances, where a company holds a loan or derivative that is matched with another financial instrument issued by it then it may be permissible under GAAP for the loan or derivative or amounts arising in respect of the loan or derivative not to be recognised in determining the company’s accounting profits or losses for the period. For example, a company may have made a loan or hold securities from which it receives income in the form of interest, and have issued fixed rate preference shares under which matching amounts are paid as dividends. While the interest income and dividend expense match each other economically, following the accounting treatment in such a case gives rise to a tax advantage, since interest is normally fully taxable and the dividends are not deductible.

13.It is HM Revenue & Customs’ (HMRC) view that such non‑recognition or de-recognition is not to be observed for tax purposes where the accounting treatment does not fairly represent the profits. But sections 311 and 312 (for loan relationships) and 599A and 599B of CTA (for derivative contracts) codify the treatment, and prevent companies arguing that where a receipt under a loan relationship (or derivative contract) is matched with a payment (such as a dividend), there is no net liability to tax, even though no deduction is due for the payment under the Corporation Tax Acts.

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