Section 28, Schedule 12: Disguised Interest
Summary
1.Section 28 introduces Schedule 12 which makes provision for amounts from arrangements that produce returns that are economically equivalent to interest (disguised interest) to be taxed as income.
Details of the Schedule
2.Paragraph 2 amends section 365 of ITTOIA by adding disguised interest to the list of savings and investment income that is charged to income tax under the rules in Part 4 of ITTOIA.
3.Paragraph 3 inserts new Chapter 2A, which contains the charge to income tax on disguised interest, into Part 4 of ITTOIA.
4.New section 381A defines the charge to tax on disguised interest. New subsection (1) establishes the scope of the income tax charge on disguised interest. It applies to an ‘arrangement’ that produces for the person who is party to it a return in relation to which an amount is ‘economically equivalent to interest’. The legislation applies to any return that is economically equivalent to interest, which is produced by the arrangement in any way. This includes anything done in relation to the arrangement from which a return will be produced, such as disposing of an instrument before maturity, or a person otherwise ceasing to be party to the arrangement.
5.New subsection (2) provides that the charge under new section 381A applies only where the return is not taxed under any other income tax provision. Hence, where a return is taxable both as disguised interest and (for example) as a profit from a deeply discounted security, the latter rules take priority. Subsection (3) ensures that this also applies where the return chargeable under that other provision is exempt from income tax.
6.New subsection (4) determines when, for the purposes of the legislation, a return is ‘economically equivalent to interest’. ‘The time value of that amount of money’ takes its meaning from case law on the meaning of interest. In BennettvOgston (15TC374) Rowlatt J described interest as ‘payment by time for the use of money’. ‘Practical likelihood’ takes its meaning from cases involving the Ramsay principle, and is to be interpreted in the light of the House of Lords’ judgment in ScottishProvidentInstitution (76TC538) as precluding attempts to manufacture a ‘falsifying’ arrangement.
7.New subsection (5) defines ‘relevant time’. The effect of these provisions is that it must be clear at the outset that the return will be produced.
8.New subsection (6) defines the term ‘arrangement’. It will include combinations of contracts or transactions that produce amounts that are economically equivalent to interest, such as box option schemes that are currently subject to rules under Chapter 12 of Part 4 of ITTOIA on guaranteed returns from disposals of futures and options. It will also include the manufactured payments and price differences that arise on stock lending and sale and repurchase arrangements (repos).
9.New section 381B charges the full amount of the return arising in the tax year. The charge on disguised interest is thus the same as that on interest taxable under Chapter 2 of Part 4 ITTOIA. ‘Full amount’ means the gross amount without deductions, and the term ‘arising’ takes its meaning from case law. In DunmorevMcGowan (52TC307) it was held that interest was taxable when it ‘enured to the benefit’ of the taxpayer. The charge on the amount arising in the tax year includes any part of the return that arises in that tax year. For example, where the arrangement is not undertaken or completed as originally envisaged, and only part of the return from the arrangement materialises, the amount taxable as having arisen is the disguised interest at that point – that is, that part of the return actually produced.
10.New section 381C establishes the person liable for income tax on disguised interest. As with section 381B, this replicates the position that applies to a person who receives or is entitled to interest under Chapter 2 of Part 4 of ITTOIA.
11.New section 381D prevents double taxation where the same income is taxable as disguised interest and under other tax provisions. It provides for HM Revenue & Customs to make ‘just and reasonable’ consequential adjustments to any other tax liabilities, where a person makes a claim.
12.New section 381E provides for an exemption from the disguised interest rules for arrangements that involve certain types of listed share. The exemption applies to shares that were issued before 6 April 2013, and to shares issued after that date that do not provide an interest-like return on issue. This is subject to an anti-avoidance provision where arrangements subsequently do secure such a return.
13.Paragraphs 4 to 17 make consequential amendments to legislation in the Taxation of Chargeable Gains Act 1992 (TCGA), ITTOIA, Income Tax Act 2007 (ITA), the Finance Act 2007, the Corporation Tax Act 2010 and the Finance Act 2010. These include the repeal of Chapter 12 of Part 4 of ITTOIA (guaranteed returns from disposals of futures and options) and the related legislation in TCGA, and Chapters 4 to 6 of Part 11 of ITA (amounts arising under stock lending and sale and repurchase arrangements (repos)).
14.Paragraph 18 contains the commencement provisions. The changes apply to returns from arrangements to which a person becomes party on or after 6 April 2013. Where a person is party to arrangements before 6 April 2013 that would have been within the rules on guaranteed returns from disposals of futures and options, or on manufactured payments and repos, returns arising from those arrangements on or after that date are taxable as disguised interest.
Background
15.Current income tax rules contain a number of provisions under which interest-like returns are charged to income tax in the same way as interest.
16.The new legislation provides a comprehensive income tax charge on disguised interest. It enables the repeal of existing anti-avoidance legislation on guaranteed returns from futures and options (which are a form of disguised interest arrangement), and allows for the simplification of income tax rules that treat certain amounts arising on stock lending and repos as payments of interest.
17.The legislation follows consultation in 2012 on a number of possible changes to income tax rules on interest. It is based on the disguised interest rule for corporates in Chapter 2A of Part 6 of the Corporation Tax Act 2009 and follows a similar principle-based approach to the drafting of legislation on financial products.
18.In due course it is anticipated that the legislation will facilitate the simplification of other income tax rules that tax returns from interest-like arrangements, such as legislation on deeply discounted securities and accrued income.
