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Avoidance involving financial arrangements

The below provides a summary of the main anti-avoidance measures announced on 6 March 2007.

Avoidance Involving Financial Arrangements | Options and group of companies | Shares Treated as Loan Relationships | Use of Offshore Funds | Derivatives | Avoiding double tax relief restrictions using Authorised Investment Funds (AIFs) | Manipulation of the settlements legislation to avoid corporation tax

Avoidance Involving Financial Arrangements
Before Finance Act 2006, special provisions applied to prevent companies using rent factoring schemes to receive in capital form amounts that were in substance proceeds from the sale of an income stream, received as part of a financing transaction. Wider provisions, the Structured Finance Arrangement rules (‘SFA’), applied from 6 June 2006, and the specific rent factoring provisions were removed. In essence, these rules prevent the avoidance of tax by the factoring of taxable receipts or the creation of tax-deductible expenses in return for a lump sum which is not taxed as income.

The new March 2007 legislation targets three ways in which companies sought to circumvent the SFA rules. These are:

• Re-financings under which the borrower may not physically receive cash or any other assets
• The transfer of assets, which are not income producing at the time of the transfer but later become income producing and are used as a form of repayment
• Collateralised assets which are substituted for other assets.

The amendments have effect in relation to arrangements whenever they were made, but should only bring into account income arising on or after 6 March 2007.

For Capital Gains purposes the SFA rules allow the transfer of the asset from the 'borrower' to the 'lender' to be ignored if:

1. the person disposing of the asset subsequently acquires it under the same arrangement; or
2. the asset ceases to exist in the hands of the lender of a connected party.

Under the pre-March 2007 rules, for the disregard to apply it needed to be known at the outset that (i) or (ii) would apply. This has been amended and the disregard applies prospectively. However, if the conditions for the disregard cease to be met at any time, the seller is treated as making a capital gains disposal for the asset’s market value at that time.

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Options and group of companies
The new legislation is aimed at preventing companies which are not part of a capital gains group using options, and a later grouping, to avoid capital gains tax.

The granting of an option involves the disposal of an asset, the option itself, on which a chargeable gain may accrue. However, if the option is exercised, the grant of the option is instead treated as part of the underlying asset sale. If at the time of the actual transfer of the asset, the transferor and transferee are part of the same capital gains group, the no gain/no loss transfer rules take precedence and both the asset transfer and the option form part of the same no gain/ no loss transfer.

The new rules carve out such disposals from the no gain / no loss group provisions where the option is exercised on or after 6 March 2007.

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Shares Treated as Loan Relationships
A change to s91B FA 1996 (one of the provisions that treats certain shareholdings which are likely to increase in value at an interest like rate as, effectively, loan assets) is of general interest, as it may broaden the scope of an existing anti-avoidance provision that disregards the effect of transactions designed to prevent the condition in s91C from applying.

What this may mean in practice is that where a group enters into a transaction which could result in a shareholding being caught by s91C (shares in a company which are likely to increase in value at an interest like rate, due to the nature of the company's assets), the group will need to carefully consider how it intends to defend against the application of that section. Typically, a group may transfer a shareholding in a trader to the affected company, such that the condition in s91C would not be satisfied - this may no longer be possible as the fair value movements taxable under s91B are to be calculated disregarding such transactions. Section 91A (targeted at partly paid share structures) is to be amended on the same basis.

These changes only apply to fair value movements from 6 March 2007.

Previously the definition of 'shares' as set out in s103(1) FA 1996, has been used for the purposes of s91A-G. However, due to perceived avoidance, this definition is to no longer to apply and there will be no specific of definition of 'shares' for s91A-G purposes. This change may have been targeted at certain preference share investment transactions structured such that any dividends/distributions were only payable on liquidation and hence the share arguably did not meet the definition of a 'share' for s91B purposes.

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Use of Offshore Funds
HMRC have received Disclosures confirming that groups have used the Offshore Funds legislation to generate tax deductions or shelter otherwise taxable income. Under certain circumstances the holders of interests in offshore funds can treat their holding as a deemed loan relationship taxable on a fair value basis. It was possible for companies in certain circumstances to use these rules to their advantage by transferring both depreciating assets and interest bearing assets to such an entity. The result would be to generate a net loan relationship debit or shelter otherwise taxable loan relationship credits.

A deduction is no longer available for the depreciating transaction in arriving at the fair value of the offshore fund, where there is a 'relevant avoidance intention'. A relevant avoidance intention is defined as:

• eliminating or reducing the credits (profits) to be brought into account; or
• creating or increasing the debits (losses) to be so brought into account.

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Derivatives
The derivatives rules have been amended to counter certain transactions in financial assets which are within the scope of the rules, even though they do not meet the 'minimal initial net investment test' for accounting purposes – e.g. certain prepaid forward contracts. The 'guaranteed return' provisions, which may have countered such transactions, were repealed in FA 2004. It may therefore have been possible to avoid taxable income by not recognising the return from such instruments in the 'investing' company’s accounts.

The amendment to the rules means that such transactions are now taxed on a fair value basis. The change has effect in relation to periods of accounting ending on or after 6 March 2007. Unlike many of the other changes announced, it is effectively retrospective as the starting point is the accounting carrying value at the beginning of that period of account.

The derivative contracts rules contain a provision which is aimed to prevent transfers of value within a group (that may reduce UK taxable income) as a result of from the lapse of a valuable option.

Disclosures to HMRC suggest that companies were partly exercising options and claiming that the existing anti-avoidance provisions could not apply as the option had not expired. The rules have now been amended and will apply unless all rights under the option are exercised in full. This is highly unlikely to catch normal commercial transactions.

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Avoiding double tax relief restrictions using Authorised Investment Funds (AIFs)
An anti-avoidance measure was announced in the 2006 Pre-Budget Report aimed at transactions designed to avoid restrictions on the amount of Double Tax Relief (DTR) available in respect of income from foreign equity investments.

Certain banks and other financial traders had been investing in such equities through 50%+ interests in AIFs (including Open Ended Investing Companies and unit trusts) to avoid this DTR restriction. The measures announced in the Pre-Budget Report were aimed at this type of investment and these have now been extended to cover Disclosed transactions where financial traders hold, individually, more than a 10% interest, but less than 50% interest.

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Manipulation of the settlements legislation to avoid corporation tax
Certain transactions resulting in exempt income for corporates due to the application of the income tax settlements legislation have been legislated against and have effect in relation to income arising on or after 6 March 2007.

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