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Revised draft legislation and associated commentary has been released with intended effect for arrangements entered into on or after 1 April 2009. This takes into account the comments received by HMRC at the various workshops that have been held since the last consultation document. Further comments on the revised consultation need to be made by 11 February 2009.

The aim of the rules is to tackle tax avoidance involving disguised interest for corporation tax purposes. The purpose of the provisions is to tax any amount or return which is economically equivalent to interest as if it were a profit arising to the company from a loan relationship. This will generally capture disguised interest in non-loan transactions.

This type of return has been clarified in the draft legislation as one that is referable to the time value of money, at a rate reasonably comparable to a commercial rate of interest and where there is no practical likelihood that it will cease to arise.

Contingent returns should therefore fall outside this definition. Any exchange gains or losses on retranslating a non-sterling interest return are specifically included. However, the rules appear to exclude any exchange differences relating to retranslation of principal amounts.

Where the disguised interest return is split between two or more persons then the provisions seek to allocate the return on a 'just and reasonable' basis between those persons.

The proposal to specifically include arrangements which seek to capitalise companies with tax losses in order to utilise the losses has been dropped following strong opposition on consultation.

Any return falling within these provisions is taxed as a profit arising to the company from a loan relationship. The loan relationship debits and credits to be brought into account in respect of the return must be determined on an amortised cost basis of accounting, whether or not this is reflected in the company's accounts. This contrasts with the existing shares-as-debt regime which seeks to tax the return on a fair value basis.

Exclusions
Shares accounted for as liabilities
Our view

Exclusions

The provisions do not apply to any arrangements which produce such a return if and to the extent that the return is brought into account for corporation tax purposes as trading income or under the loan relationships, derivative contracts, or intangible fixed asset regimes. HMRC commentary suggests that this clause confirms the exclusivity of the loan relationships regime, for example, in the context of the specific provisions dealing with index-linked gilts. However, the drafting does not appear to put this beyond doubt. HMRC also comment that Section 37 TCGA 1992 should prevent any double charge as a capital gain but would welcome views.

In any event, the rules do not apply to any arrangements which produce such a return unless the main purpose, or one of the main purposes, of the arrangement is to secure that the return is not brought into account as income for corporation tax purposes. This purpose-based exclusion is much more consistent with other 'unallowable purpose' provisions within existing statute.

The main positive development is the general exclusion for intra-group shareholdings and non-group shareholdings which are subject to CFC apportionment (or would be but for a CFC exemption). A group company for these purposes is defined as a company within a capital gains group. This should make it clear that the target area for these proposals is corporation tax avoidance on disguised interest income from third party 'deposit'-type arrangements.

The intra-group and CFC shareholding exclusions only apply where the arrangement is such that it is the share alone that produces the disguised interest return. There are also requirements that the shares are fully-paid up with no unpaid amounts or contingent obligations outstanding.

Shares accounted for as liabilities

The introduction of the disguised interest rules should permit the repeal of various other anti-avoidance provisions including the shares-as-debt rules, quasi-stock lending arrangements and repo anti-avoidance. The shares-as-debt rules targeted at redeemable preference shares are to be replaced with a wider definition of any share that is accounted for as a liability.

As with the current rules, the shares still need to be designed to produce a return which equates, in substance, to the return on the investment of money at a commercial rate of interest. The investing company also needs to have an unallowable purpose in acquiring/holding the shares for the rules to apply in line with the existing Section 91D provisions.

A major positive development is an exclusion where the issuing company and investing company are 'connected' companies. For these purposes 'connected' should follow the loan relationships connection test.

Any shares falling within these provisions are taxed under the loan relationship provisions, and accordingly any return, including distributions, should be taxable under the core charging provisions of the loan relationships code. This contrasts with the current shares-as-debt rules which tax on a fair value basis.

Similarly, transitional arrangements for shares becoming subject to these rules deem a disposal and acquisition at a 'notional carrying value', i.e. the carrying value in the accounts at that time. Again, this contrasts with the existing regime where transition is on a fair-value basis.