Overview
1057.Chapter 1 contains the rules relating to relief for interest paid given by deduction in calculating net income. It is based on sections 353 to 368 of ICTA.
1058.The Mortgage Interest Relief At Source provisions in sections 369 to 379 of ICTA and the related provisions in section 365 of ICTA for relief for interest on a loan to purchase a life annuity are obsolescent. They are not rewritten in this Act, but remain in ICTA.
Section 383: Relief for interest payments
1059.This section is an introduction to the Chapter. It is based on sections 353, 359, 360, 361, 362 and 364 of ICTA.
1060.Subsection (2) lists the seven provisions about the purposes for which loans have to be used if the interest on them is to be eligible for relief. Those purposes do not include the generality of purposes for which loans are taken out in the course of a trade or property business, as interest will normally be an allowable deduction in computing the income from that source.
1061.Relief is given as a deduction in computing net income of the year in which payment is made. So if the interest exceeds the income from which it can be deducted, relief for the excess interest is generally lost. The exception from this rule in section 405 is signposted by subsection (5)(e).
Section 384: General restrictions on relief under Chapter
1062.This section sets out two restrictions on relief for interest paid. It is based on section 353(3) of ICTA.
Section 385: General provisions about loans
1063.This section brings together some general rules which apply to the loan itself. It is based on sections 359, 360, 361, 362, 364 and 367 of ICTA.
1064.With the exception of section 367 of ICTA, the source legislation provides a condition in each of the rules that the loan must be to defray money applied for a particular purpose. The rewritten provisions simply refer to a loan being “used”.
1065.Subsection (1) expands on what “used” is to be taken to mean. In particular, with the exception of a loan to pay inheritance tax, it covers the case of expenditure already incurred.
1066.The restrictions in subsections (2) and (3) do not apply to loans to buy plant or machinery (sections 388 and 390 of this Act).
Section 386: Loans partly meeting requirements
1067.This section explains what happens if a loan (“the mixed loan”) is only partly used for a qualifying purpose. It is based on section 367(4) of ICTA.
1068.Subsection (1) explains that the qualifying part of the loan is itself treated as a loan within this Chapter.
1069.Subsection (2), read withsubsection (4), provides that in respect of a mixed loan within subsection (1) only interest on the part of the loan used for qualifying purposes is eligible for relief. The apportionment is made in a way that reflects the application of the money at the time the loan is used.
1070.Subsection (3), read withsubsection (4), provides that if part of the loan is repaid, then the qualifying and non-qualifying parts of the original loan are treated as repaid in the same proportions that the loan was first used. A stricter rule applies in a case where there is a recovery of capital which was the subject of a qualifying investment (see section 406(4)).
1071.The rule dealing with partial repayments is based on section 367(4) of ICTA, but modified so as to apply to all cases. See Change 66 in Annex 1.
Section 387: Exclusion of double relief etc
1072.This section contains restrictions which ensure that relief is only given once for a particular interest payment, and penalise attempts to switch between claiming relief as a trade etc expense and as a deduction from income under this Chapter. It is based on section 368 of ICTA.
1073.Subsection (1) contains the main rule. It denies relief elsewhere for any payment of interest for which relief is given under this Chapter.
1074.Subsections (2) to (6) contain further rules which prohibit relief under this Chapter in cases where the interest or “connected” interest is claimed as a trading etc expense. They derive from section 368(3) and (5) of ICTA. Section 52 of ITTOIA, based on section 368(4) and (5) of ICTA, makes similar provision in relation to restricting relief for interest in calculating the profits of a trade.
1075.Subsection (7) is based on section 368(6) of ICTA but has been adapted to fit better with Self Assessment. See Change 67 in Annex 1.
1076.Section 368(2) of ICTA is redundant and has not been rewritten. See the commentary on section 404.
Section 388: Loan to buy plant or machinery for partnership use
1077.This section is the first of two dealing with a loan used by a partner in providing plant or machinery for partnership use. It is based on section 359(1) of ICTA.
1078.The reference to a vocation being carried on by a partnership contained in the source legislation has not been included in this section, or elsewhere, because a partnership cannot carry on a vocation.
1079.Subsection (2) makes it clear that the plant or machinery must be in use and that the partnership must be entitled to a capital allowance or balancing charge in respect of it for the period of account in which the interest is paid. The “in use” requirement is not explicitly specified in section 359(1) of ICTA, but is clear from section 359(2) and the wording of section 264 of CAA. The requirement in section 359(1) of ICTA that the plant or machinery must belong to the individual partner is not included as it is contained in section 264 of CAA.
1080.It is also made clear that ordinary property businesses (if carried on in partnership) are within the types of partnership business that qualify. See Change 68 in Annex 1.
1081.Subsection (3) ensures that relief remains available where the plant remains within the capital allowances regime, even if no allowance or balancing charge arise in the period of account. See Change 69 in Annex 1.
1082.Subsection (4) makes it explicit that the appropriate definitions of “capital expenditure” and “period of account” are those in sections 4 and 6 of CAA, which apply generally for capital allowances purposes, rather than the definitions in section 989 of this Act.
Section 389: Eligibility requirements for interest on loans within section 388
1083.This section contains two conditions which have to be met if the interest is to be eligible for relief. It is based on section 359(1) and (2) of ICTA.
1084.Both conditions relate to circumstances at the time the interest is paid.
1085.Subsections (4) and (5) provide an apportionment rule if the plant or machinery is used partly for the purposes of the trade, profession or ordinary property business and partly for other purposes. As regards the inclusion of ordinary property businesses, see Change 68 in Annex 1 and the commentary on section 388.
Section 390: Loan to buy plant or machinery for employment use
1086.This section is the first of two dealing with a loan used by an individual to provide plant or machinery for use as an employee or office-holder. It is based on section 359(3) of ICTA.
1087.Subsection (2) makes it clear that the plant or machinery must be in use, that it must belong to the individual and that the individual must be entitled to a capital allowance or balancing charge in respect of it for the tax year in which the interest is paid. The “in use” requirement is explicitly specified in section 359(3) of ICTA. It is necessary to retain the “belonging to” test here as that is not a requirement of eligibility to capital allowances.
1088.Subsection (3) corresponds to section 388(3). See Change 69 in Annex 1 and the commentary on section 388.
1089.Section 37 of CAA (exclusion where sums payable in respect of depreciation) may operate to deny entitlement to capital allowances in respect of the expenditure met by the employee. In such a case subsection (4) preserves entitlement to relief for the interest if a contribution to the expenditure has been made by the individual’s employer.
Section 391: Eligibility requirements for interest on loans within section 390
1090.This section contains two conditions which have to be met if the interest is to be eligible for relief. It is based on section 359(3) and (4) of ICTA.
1091.Both conditions relate to circumstances at the time the interest is paid.
Section 392: Loan to buy interest in close company
1092.This section deals with conditions for relief for interest on a loan to buy an interest in a close company. It is based on section 360(1), (3A) and (4) of ICTA.
1093.The section is the first of four dealing with this relief.
1094.Subsection (2) provides that the company in which the investment is made with the borrowed money must be a close company, but must not be a close investment-holding company within section 13A(1) of ICTA. In addition, the investment must either be in the ordinary shares of the company, or in the form of a loan (or a replacement loan) which is used for specified business purposes, or both.
1095.It is clear from section 363(4) of ICTA, under which a replacement loan and the original loan are treated as one, that a replacement loan only qualifies under this section if it replaces an earlier loan for the same qualifying purpose. This point has been made explicit in this section.
1096.Subsection (3) contains a further condition that the investment must not be in ordinary shares for which relief is given under the enterprise investment scheme income tax or capital gains tax provisions. See Schedule 2 Part 9 for transitional provisions where the shares were acquired before 6 April 1989.
Section 393: Eligibility requirements for interest on loans within section 392
1097.This section sets out conditions relating to circumstances at the time the interest is paid, or during the period of the loan. It is based on section 360(1), (2) and (3) of ICTA.
1098.The first such condition, in subsection (1)(a), is that at the time the interest is paid, the company must not be a close investment-holding company. It says nothing about whether the company is to be a close company. This accords with Statement of Practice 3/78, which explains that section 360(2)(a) of ICTA does not require the company to be close at the time the interest is paid.
1099.The second condition, insubsections (1)(b) and (2), is that during the period of the loan the borrower must not have recovered any capital from the company apart from any amount taken into account under section 406(2) of this Act.
1100.The final condition, in subsections (1)(b), (3) and (4), is in two parts, and it is sufficient that either part is satisfied.
1101.The first part is in subsection (3) and requires the borrower to hold some ordinary shares in the company and to have worked full time for the company during the period from the use of the loan to the payment of the interest.
1102.The second part, in subsection (4), requires the borrower to have a material interest in the company and also that, if the company exists for the purposes of holding investments or other property, none of that property is a residence of that individual, unless (broadly speaking) that individual has worked full time for the company. (For the meaning of “material interest” see section 394 and the commentary on that section.)
1103.The source legislation for the material interest condition does not specify over what period the individual has to have worked full-time for the company. The reference to subsection (3)(b) makes it explicit that regard is to be had to the same period as is referred to in the full-time working condition itself.
Section 394: Meaning of “material interest” in section 393
1104.This section defines “material interest” for the purposes of section 393(4)(a). It is based on section 360A(1) of ICTA.
1105.The source legislation does not give the meaning of “control”. Subsection (5) makes it clear that it is the definition in section 416 of ICTA which applies. The same definition is applied in section 395.
Section 395: Meaning of “associate” in section 394
1106.This section defines the term “associate”. It is based on section 360A(2), (4) to (7) and (10) of ICTA.
1107.The reference in section 360A(5) to Schedule 8 to ICTA has been replaced by a reference to the relevant provisions in ITEPA.
1108.Section 360A(8) and (9) of ICTA relate to loans made before 14 November 1986. Those rules are contained in Part 9 of Schedule 2 to this Act.
1109.Section 360A(3) of ICTA is redundant and has not been rewritten.
Section 396: Loan to buy interest in employee-controlled company
1110.This section deals with conditions for relief on interest on a loan to buy an interest in an employee-controlled company. It is based on section 361(3) to (8) of ICTA.
1111.This section deals with the conditions relating to the employee-controlled company and ways of investing in it. Section 397 deals with the conditions that relate to circumstances at the time the interest is paid.
1112.The condition in subsection (2) is that the loan is applied in acquiring part of the ordinary share capital of a company that has recently become or becomes an employee-controlled company. As with section 392, relief is available for a loan replacing one that met the conditions in this section.
1113.Subsection (3) defines when a company is “employee-controlled”. The definition requires more than 50% of the issued ordinary share capital and more than 50% of the voting power to be held by persons who are full-time employees of the company.
1114.Subsection (4) provides that, if an individual holds more than 10% of either the ordinary share capital or the voting power, the excess over 10% is regarded as owned by a person who is not a full-time employee of the company and so does not count towards the 50% test in subsection (3).
Section 397: Eligibility requirements for interest on loans within section 396
1115.This section sets out four conditions relating to circumstances at the time the interest is paid, or during the period of the loan. It is based on section 361(3), (4) and (8) of ICTA.
1116.Condition B requires the company to be employee-controlled for at least nine months in the tax year in which the interest is paid (or to become employee-controlled first in that year).
1117.Condition C is that the claimant is a full-time employee of the company throughout the period between the date on which the loan is used (“the use date”) and the date the interest is paid. If the individual ceased to be a full-time employee no more than 12 months before the interest payment date, then it is sufficient that the employee worked full time for the company from the use date until that date.
Section 398: Loan to invest in partnership
1118.This section deals with conditions for relief for interest on a loan to invest in a partnership. It is based on section 362(1) of ICTA.
1119.This section deals with the conditions relating to ways of investing in the partnership. Section 399 deals with the conditions that relate to circumstances at the time the interest is paid.
1120.Subsection (2) provides that the loan qualifies for relief if the proceeds are used in either buying a share in a partnership or contributing or advancing money to a partnership that is used for a trade or profession carried on by the partnership. As explained in the commentary on section 388, no reference is made to “vocation” as a partnership cannot carry on a vocation. As with section 392, relief is available for a loan replacing one that met the conditions in this section.
Section 399: Eligibility requirements for interest on loans within section 398
1121.This section sets out two conditions relating to circumstances during the period of the loan, both of which must be met. It is based on section 362 of ICTA and, in relation to film partnerships, on section 75(1) of FA 2006.
1122.Condition A is that the individual to whom the loan is made must be a partner in the partnership throughout the period from the making of the investment to the payment of the interest. Relief is not available if the partnership is an investment LLP or a limited partnership in which the individual is a limited partner.
1123.Where the special rules for film partnerships in section 400 apply, subsection (4) provides that relief is restricted to 40% of the interest that would otherwise be eligible for relief.
1124.Subsection (5) provides that certain senior employees of the partnership may count as partners for the purposes of this section, enacting Statement of Practice SP A33. See Change 70 in Annex 1.
Section 400: Film partnerships
1125.This section sets out the circumstances in which relief is restricted to 40% of the interest that would otherwise be eligible for relief. It is based on section 75 of FA 2006.
1126.The restriction applies only if the money is invested in a film partnership and secured on an asset or activity of a second partnership, the “investment partnership”, of which the individual is or has been a member. The individual must also be entitled to a lower proportion of the profits of the investment partnership than the proportion of capital that he or she contributed to that partnership.
1127.In relation to the calculation of the latter proportion, subsection (3) provides rules about what constitutes the partnership capital and subsection (4) provides rules for identifying which part of that capital has been contributed by the claimant. In subsection (4) it is made explicit that only amounts that actually form part of the total investment partnership’s capital are taken into account.
Section 401: Loan to invest in co-operative
1128.This section deals with conditions for relief for interest on a loan to invest in a co-operative. It is based on section 361(1) and 363(5) of ICTA.
1129.This section is the first of two dealing with this relief and deals with the conditions relating to the co-operative and ways of investing in it. Section 402 deals with the conditions that relate to circumstances at the time the interest is paid.
1130.Subsection (2) provides that the loan qualifies for relief if the proceeds are used in either buying shares in a co-operative or lending money to a co-operative or its subsidiary which is used for the business purposes of that body. As with section 392, relief is available for a loan replacing one that met the conditions in this section.
1131.The condition in section 361(2)(a) of ICTA that the loan only qualifies if it was made after 10 March 1981 has not been reproduced. So, if any loans made on or before that date still exist, the interest on them will now be eligible for relief. See Change 71 in Annex 1.
Section 402: Eligibility requirements for interest on loans within section 401
1132.This section sets out three conditions relating to circumstances at the time the interest is paid or during the period of the loan, all of which must be met. It is based on section 361(2) of ICTA.
Section 403: Loan to pay inheritance tax
1133.This section provides relief for interest on money borrowed by personal representatives to pay certain amounts of inheritance tax. It is based on section 364(1), (3) and (4) of ICTA.
1134.In order for the personal representatives to obtain a grant of representation or confirmation, they have to pay the inheritance tax for which they are liable on delivery of their account under section 226(2) of IHTA. Relief is available for interest on a loan to pay this tax. Relief is not available for interest on a loan to pay inheritance tax that falls due at a later date. The source legislation in section 364(1)(a) of ICTA is written in language relating to estate duty. It has been brought up to date in subsection (2). See Change 72 in Annex 1.
1135.Subsection (3) clarifies that a document from an officer of Revenue and Customs giving details of inheritance tax payable will be accepted in support of a claim under this section. The source legislation refers to a certificate from the Board. See Change 5 in Annex 1.
Section 404: Eligibility requirements for interest on loans within section 403
1136.This section provides that interest on loans to pay inheritance tax is eligible for relief only if it is paid in respect of a period ending within 12 months of the loan being made. It is based on section 364(1) and (4) of ICTA.
1137.Section 364(4)(b) of ICTA states that “references to interest in respect of a period ending with a given time apply whether or not interest continues to run after that time”. This has been rewritten by using the words “so far as”.
1138.Section 368(2) of ICTA is redundant and has not been rewritten. See Change 73 in Annex 1.
Section 405: Carry back and forward of relief for interest on loans within section 403
1139.This section provides for the carry back or forward of interest eligible for relief by virtue of section 403. It is based on section 364(2) of ICTA.
1140.Relief for interest on a loan to pay inheritance tax is the only interest relief that may be deducted from income of a tax year other than the year in which it was paid.
Section 406: Effect of recovery of capital in the case of some loans
1141.This section deals with what happens if an individual to whom the loan was made recovers any capital from the business entity in which the investment was made. It is based on section 363(1) of ICTA.
1142.Rules in the particular provisions concerned (eg section 393(2)) disallow relief completely if any capital is recovered unless this section applies. If this section applies, (and it applies to most recoveries), then relief is only reduced in the proportion that the amount of the recovery bears to the amount of the loan (or, where only part of the loan qualified, to the qualifying part of the loan).
1143.The source legislation restricted the application of this rule to cases where the recovered capital was not applied in making a loan repayment. In cases where the recovered capital was so applied relief was, in strictness, lost completely. The rule has been rewritten to ensure that it applies in all cases where capital is recovered. See Change 74 in Annex 1.
1144.Subsection (6) makes it clear that this provision applies only if section 407 treats an amount of capital as having been recovered from the business entity.
Section 407: Events counting as recovery of capital for section 406
1145.This section explains which events count as the recovery of capital for the purposes of section 406. It is based on section 363(2) of ICTA.
1146.Subsection (1) identifies the cases relating to an investment in a company (whether a close company or employee-controlled), subsection (2) identifies the cases relating to an investment in a partnership and subsection (3) identifies the cases relating to an investment in a co-operative.
1147.Subsection (4) provides that if there is a sale or assignment that is not at arm’s length, market value consideration is used instead of actual proceeds. Section 1008(1) provides that in Scotland “assignment” means “assignation”.
Section 408: Replacement loans
1148.This section makes provision for cases where a loan, interest on which would be eligible for relief under some provisions of this Chapter, is used in repaying another qualifying loan. It is based on section 363(4) of ICTA.
1149.Subsection (3) ensures that the two loans are treated as a single loan for the purposes of this Chapter. In order that this rule works correctly when looking at how the proceeds are applied, it is subject to subsection (5) under which references to the use of a loan are generally taken as referring to the use of the original loan.
1150.Subsection (4) makes it clear that any restriction under section 406 (recovery of capital) applies if capital is recovered while the second loan is in place.
Section 409: Business successions between partnerships
1151.This section ensures continuity of relief in certain cases where, in law, a partnership is dissolved. It is based on ESC A43.
1152.Under section 362 of ICTA, relief for interest paid is only available for so long as the individual is a partner in the partnership in which the investment is made. In strictness, the admission or departure of a partner results in a new partnership, but it has never been the practice to refuse relief in these circumstances. Indeed, ESC A43 goes further and allows relief to continue when there is a partnership reconstruction involving a merger or demerger.
1153.Subsections (1) and (2) of this section gives statutory effect to current practice and ESC A43 to the extent that they relate to partnership changes and reconstructions. See Change 75 in Annex 1.
1154.Subsection (3) builds into the section the extended meaning of “member of a partnership” that is explained in Change 70 in Annex 1. See also the commentary on section 399.
1155.ESC A43 also deals with other types of business successions including the incorporation of a partnership. These cases are addressed in section 410.
Section 410: Other business successions and reorganisations
1156.This section ensures continuity of relief in certain cases where a partnership is incorporated into another of the business entities covered by this Chapter. It is based on ESC A43.
1157.Under each of the sections in the source legislation dealing with investments in (including loans to) qualifying business entities, relief for interest paid is only available for so long as the shares are held in or the loan is made to the original business entity. In the case where the investment is in a partnership, the individual must remain a partner in the partnership in which the investment is made.
1158.It follows that relief strictly ceases to be available if a partnership is incorporated into one of the other types of qualifying business entity or there is a reconstruction in which the individual’s original shares are replaced by shares in a different qualifying business entity. This rule is relaxed by ESC A43 which allows relief to continue if this sort of business succession occurs. This section legislates that part of ESC A43. See Change 75 in Annex 1 and the commentary on section 409.
1159.This section only applies to genuine business successions. It is not considered to apply if an investment in one entity is replaced by another investment within the same entity. An example is the conversion of convertible loan stock into ordinary shares.
Section 411: Ineligibility of interest where business is occupation of commercial woodlands
1160.This section rules out relief if certain of the business entities covered by this Chapter carry on the business of the commercial occupation of woodlands. It is based on paragraph 3 of Schedule 6 to FA 1988.
1161.The section applies if the loan is invested in a close company, an employee-controlled company or a partnership, and excludes relief for what is in effect an investment into an entity carrying on a tax-exempt activity. This section also provides rules that apply if only part of the business is the exempt activity.
Section 412: Information
1162.This section makes provision for the lender of a loan covered by this Chapter to provide information to the borrower on request. It is based on section 366 of ICTA.
1163.The source legislation requires the person claiming relief to submit to an officer of Revenue and Customs a written certificate from the lender containing details of the debt and interest. Under Self Assessment, such statements are not generally required. Such a certificate will only be required when an officer raises enquiries into the return or the claim. The provision has therefore been recast in terms of the claimant being able to obtain a certificate from the lender if he or she needs or wants to do so. Lenders will no longer need to issue certificates routinely.
