Chapter 5B: Finance arrangements
Overview
1106.This Chapter is based on sections 774A to 774G to ICTA, the rules on structured finance arrangements introduced by FA 2006. It stops a number of schemes which are intended to enable taxpayers to borrow money and obtain effective tax relief for both interest and repayment of principal.
1107.A “finance arrangement”, within this Chapter, is an arrangement where in accordance with GAAP a person (“the borrower”) records in its accounts a financial liability in respect of a sum (“advance”) paid by “the lender”, and that sum is paid to acquire assets (including an income stream), which will be used to repay the advance.
1108.Where there is a finance arrangement which would have had the effect that either:
income or receipts that would have been brought into account by the borrower for tax purposes are not brought into account; or
the borrower would have become entitled to a deduction in computing its income or profits for tax purposes,
then
the finance arrangement does not have that effect, with the result that the income from the transferred asset continues to be taxed on the borrower; and
any disposal or reacquisition of the asset is disregarded for the purposes of TCGA.
1109.Income tax relief is allowed for the amount of any interest or “finance charge” in respect of the finance agreement shown in the borrower’s accounts.
1110.This Chapter corresponds to Chapter 2 of Part 16 of CTA 2010, which makes similar provision for corporation tax. It has the following structure.
Sections 809BZA to 809BZE deal with “type 1 finance arrangements”: the simple case, not necessarily involving a partnership.
Sections 809BZF to 809BZI deal with “type 2 finance arrangements”: the first of two complex partnership cases.
Sections 809BZJ to 809BZL deal with “type 3 finance arrangements”: the second of two complex partnership cases.
Sections 809BZM to 809BZP make exceptions to these rules.
Sections 809BZQ to 809BZS are interpretative.
Section 809BZA: Type 1 finance arrangement defined
1111.This section defines a form of arrangement, labelled a “type 1 finance arrangement”, which falls within this legislation. It is based on section 774A of ICTA.
1112.Subsection (1) provides that two conditions must be met if an arrangement is to be a type 1 finance arrangement.
1113.The word “arrangement” appears in subsection (1) for the first time in this Chapter. See section 809BZR.
1114.Subsection (2) specifies condition A, which concerns the terms of the arrangement. There are three tests in condition A, all of which must be passed if the condition is to be met. To summarise:
a borrower must “receive” an advance from a lender (see subsection (2)(a));
the borrower (or a person “connected” with the borrower) must “dispose” of an asset (the security) to, or for the benefit of, the lender (or a person “connected” with the lender) (see subsection (2)(b)); and
the lender (or a person “connected” with the lender) must be entitled to “payments in respect of” the security (see subsection (2)(c)).
1115.An ordinary secured loan would not be a type 1 finance arrangement, because it would not satisfy subsection (2)(b) or, if it did, it would not satisfy subsection (2)(c).
1116.The first reference in this Chapter to a person receiving an asset is in subsection (2)(a). See section 809BZS(2).
1117.Subsection (2)(b) is the first of a number of provisions in this Chapter which refer to persons being “connected”. In the source legislation, section 774G(4) of ICTA gives that expression the meaning given by section 839 of that Act. The provisions in question are rewritten as new sections of ITA, inserted by this Act. Section 1021(1) of ITA applies the definition of “connected” persons in section 993 of that Act. Section 774G(4) of ICTA is not being rewritten as a separate proposition.
1118.The first reference in this Chapter to a disposal of an asset is in subsection (2)(b). See section 809BZS(3).
1119.The first reference in this Chapter to payments in respect of an asset is in subsection (2)(c). See section 809BZS(4).
1120.Subsection (3) specifies condition B, which is about accounting. To summarise, the payments mentioned in subsection (2)(c) must be, for accounting purposes, payments of principal rather than interest.
1121.The first reference in this Chapter to a person’s accounts is in subsection (3)(a). See section 809BZQ(2) and (4).
1122.The first reference in this Chapter to an amount being recorded in accounts as a financial liability is in subsection (3)(a). See section 809BZQ(3).
Section 809BZB: Certain tax consequences not to have effect
1123.This section disapplies certain tax consequences of a type 1 finance arrangement if certain conditions are met. It is based on sections 774A(4), 774B(1), (1A), (2) and (3) and 774G(2) of ICTA.
1124.Under subsections (1) and (2), if – but for this section – a type 1 finance arrangement would have the “relevant effect”, then it does not.
1125.Subsection (3) defines the “relevant effect”, and subsection (4) defines the “relevant effect” if the borrower is a partnership. Each of those subsections specifies three alternative effects.
Section 809BZC: Payments treated as borrower’s income
1126.This section treats the payments mentioned in section 809BZA(2)(c) as income of the borrower. It is based on sections 774A(4), 774B(1) and (1B) to (3) and 774G(2) of ICTA.
1127.Under subsection (1), this section only applies if:
there is a type 1 finance arrangement;
section 809BZB(2) and the corresponding corporation tax provision do not stop this arrangement having the relevant effect; and
the borrower is either (a) within the charge to income tax or (b) a partnership at least one member of which is within the charge to income tax.
Section 809BZD: Deemed interest if borrower is not a partnership
1128.This section allows income tax relief to be given if there is a type 1 finance arrangement and the borrower is not a partnership. It is based on section 774B(4), (7) and (8) of ICTA.
1129.As well as specifying the conditions for this section to apply, subsection (1) introduces the person (namely, the borrower) eligible for income tax relief.
1130.Subsection (2) permits the borrower mentioned in subsection (1) to treat the amount as interest payable on a loan. If the relevant statutory conditions are met, the deemed interest qualifies for income tax relief under Chapter 1 of Part 8 of ITA.
1131.If subsection (2) deems there to be interest payable, subsection (3) determines when it is deemed to be paid.
Section 809BZE: Deemed interest if borrower is a partnership
1132.This section allows income tax relief to be given if there is a type 1 finance arrangement and the borrower is a partnership. It is based on section 774B(4) and (6) to (8) of ICTA. It has a similar structure to section 809BZD; see the commentary on that section.
Section 809BZF: Type 2 finance arrangement defined
1133.This section defines a form of arrangement, labelled a “type 2 finance arrangement”, which falls within this legislation. It is based on section 774C(1) to (3) of ICTA.
1134.A type 2 finance arrangement works like this.
Under the arrangement, a transferor disposes of an asset to a partnership.
This partnership is one of which the transferor is a member immediately after that disposal – it does not matter whether it was a partner before the disposal.
The partnership receives an advance from a lender.
The accounts of the partnership record in accordance with GAAP for that period a financial liability in respect of the advance.
There is a “relevant change” in relation to the partnership. Broadly speaking, a “relevant change” affects the lender. Either the lender (or a person connected with the lender) becomes a member of the partnership, or else there is a change in the profit share of the lender (or of a person connected with the lender). See section 809BZG.
The share of the lender (or other person involved in the relevant change) in the profits of the partnership is determined (wholly or partly) by reference to payments in respect of the asset disposed of.
In accordance with GAAP the payments reduce the amount of the financial liability.
1135.The lender’s advance is thus made in the form of a contribution to the partnership and its profit share is such that payments are made to it which repay that contribution together with interest. Once the repayment with interest has been made it is likely that there are arrangements under which the lender ceases to be a member of the partnership or to share in the profits of it.
1136.If the relevant change would (but for section 809BZH) have the “relevant effect” (as defined in subsection (3) of that section), then that section negates the relevant effect.
1137.Subsection (1) provides that two conditions must be met if an arrangement is to be a type 2 finance arrangement.
1138.Subsection (2) specifies condition A, which concerns the terms of the arrangement. There are five tests in condition A, all of which must be passed if the condition is to be met.
1139.Subsection (3) specifies condition B, which is about accounting. To summarise, the payments mentioned in subsection (2)(e) must be, for accounting purposes, payments of principal rather than interest.
Section 809BZG: Relevant change in relation to partnership
1140.This section defines “relevant change”. It is based on section 774C(2), (4), (6) and (7) of ICTA.
1141.This section applies for the purposes of this Chapter and, therefore, is used in defining both “type 2 finance arrangement” and “type 3 finance arrangement”. See sections 809BZF(2)(d) and 809BZJ(2)(c).
1142.Subsection (5) defines “person involved in a relevant change” for the purposes of this Chapter.
Section 809BZH: Certain tax consequences not to have effect
1143.This section disapplies certain tax consequences of a type 2 finance arrangement if certain conditions are met. It is based on sections 774D(1) to (4) and 774G(2) of ICTA.
1144.Under subsections (1) and (2), if – but for this section – a relevant change in relation to the partnership would have the “relevant effect”, then it does not.
1145.Subsection (3) defines the “relevant effect”. It specifies three alternative effects.
Section 809BZI: Deemed interest
1146.This section allows income tax relief to be given if there is a type 2 finance arrangement. It is based on section 774D(6), (8), (12) and (13) of ICTA.
1147.Subsection (1) lays down the conditions for this section to apply and introduces the person (namely, the transferor) eligible for income tax relief.
1148.Subsection (2) permits the transferor to treat the amount mentioned in subsection (1)(c) as interest payable on a loan. If the relevant statutory conditions are met, the deemed interest qualifies for income tax relief under Chapter 1 of Part 8 of ITA.
1149.Subsection (3) extends subsection (1)(c) to cover the case in which the transferor prepares accounts which, in accordance with GAAP, record an amount as a finance charge in respect of the advance (even though the partnership does not).
1150.If subsection (2) deems there to be interest payable, subsection (4) determines when it is deemed to be paid.
Section 809BZJ: Type 3 finance arrangement defined
1151.This section defines a form of arrangement, labelled a “type 3 finance arrangement”, which falls within this legislation. It is based on section 774C(1), (4) and (5) of ICTA.
1152.A type 3 finance arrangement is similar to a type 2 finance arrangement. See the commentary on section 809BZF. But a type 3 finance arrangement deals with a case where an existing partnership enters into an arrangement under which the lender becomes a partner and shares in the profits to an extent sufficient to repay its contribution with interest. It differs from a type 2 finance arrangement in that (a) the partnership cannot be one formed for the purposes of the arrangement and (b) there is no reference to a transfer of an asset or a transferor.
1153.Subsection (1) provides that two conditions must be met if an arrangement is to be a type 3 finance arrangement.
1154.Subsection (2) specifies condition A, which concerns the terms of the arrangement. There are four tests in condition A, all of which must be passed if the condition is to be met.
1155.Subsection (3) specifies condition B, which is about accounting. To summarise, the payments mentioned in subsection (2)(d) must be, for accounting purposes, payments of principal rather than interest.
1156.Conditions A and B in this section are very similar to conditions A and B in section 809BZF (type 2 finance arrangement defined). For the provisions which differ, see sections 809BZF(2)(a) and (b) and 809BZJ(2)(a).
Section 809BZK: Certain tax consequences not to have effect
1157.This section disapplies certain tax consequences of a type 3 finance arrangement if certain conditions are met. It is based on sections 774D(1) to (4) and 774G(2) of ICTA.
1158.Under subsections (1) and (4), if – but for this section – a relevant change in relation to the partnership would have the “relevant effect”, then it does not.
1159.Subsection (2) defines the “relevant effect”. It specifies three alternative effects. The “relevant effect” in subsection (2) is very similar to the “relevant effect” in section 809BZH(3), which makes corresponding provision for type 2 finance arrangements. But the “relevant effect” in subsection (2) is an effect on a “relevant member” (as defined in subsection (3)), whereas the “relevant effect” in section 809BZH(3) is an effect in relation to the transferor.
Section 809BZL: Deemed interest
1160.This section allows income tax relief to be given if there is a type 3 finance arrangement. It is based on section 774D(3), (9) and (11) to (13) of ICTA.
1161.Subsection (1) lays down the conditions for this section to apply and introduces the person (namely, a relevant member, as defined in subsection (5)) eligible for income tax relief.
1162.Subsection (2) permits the relevant member to treat the amount mentioned in subsection (1)(c) as interest payable on a loan. If the relevant statutory conditions are met, the deemed interest qualifies for income tax relief under Chapter 1 of Part 8 of ITA.
1163.Subsection (3) extends subsection (1)(c) to cover the case in which a relevant member prepares accounts which, in accordance with GAAP, record an amount as a finance charge in respect of the advance (even though the partnership does not). This relevant member need not be the relevant member mentioned in subsection (2).
1164.If subsection (2) deems there to be interest payable, subsection (4) determines when it is deemed to be paid.
Section 809BZM: Exceptions: preliminary
1165.This section introduces a group of sections which make exceptions to sections 809BZA to 809BZL. It is new.
Section 809BZN: Exceptions
1166.This section specifies exceptions to sections 809BZA to 809BZL. It is based on section 774E(1) to (6) of ICTA.
1167.Subsection (6) refers to Part 10A of ITA (alternative finance arrangements), which is inserted by Schedule 2 to this Act and is based on Chapter 5 of Part 2 of FA 2005.
Section 809BZO: Exceptions: relevant person
1168.This section defines “relevant person” for the purposes of section 809BZN. It is based on section 774E(7) of ICTA.
1169.Section 774E of ICTA contains priority rules which prevent sections 774B and 774D of ICTA applying if other tax enactments apply. The definition of “relevant person” in section 774E(7) of ICTA interprets the references to a relevant person in section 774E(1) and (3) of ICTA. The wider the meaning of “relevant person”, the more likely it is that section 774E(1) and (3) of ICTA disapply the anti-avoidance rules in sections 774B and 774D of ICTA.
1170.The only possibly uncertain element of the meaning of “relevant person” is the reference to a person connected with the borrower. Section 774G(4) of ICTA provides that the definition of “connected” in section 839 of ICTA applies “for the purposes of sections 774A to 774D”. It is not clear whether the use of “connected” in section 774E(7) of ICTA can be said to be “for the purposes of sections 774A to 774D”. But it is at any rate clear that section 774E only operates effectively as a priority rule if, at the very least, the reference in section 774E(7) of ICTA to persons connected with the borrower includes all persons who as a result of section 839 of ICTA would be treated as connected to the borrower.
1171.Whether the reference goes (or needs to go) wider than that group is open to argument. The inclusive definition in subsection (5) preserves the scope for making that argument while giving the maximum possible certainty.
Section 809BZP: Power to make further exceptions
1172.This section enables the Treasury to make further exceptions to sections 809BZA to 809BZL. It is based on section 774F of ICTA.
Sections 809BZQ to 809BZS: Accounts; arrangements; assets
1173.These interpretative sections are based on section 774G(1), (3) and (5) to (6) of ICTA.
