Tax Update - Anti-avoidance targets 'post-tax' advantages
01 May 2009
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This update describes a proposed change of law relating to tax
relief for interest paid by individuals. For the time being, the
target and the direct effect of the change of law is quite
narrow.
However, this update will be of interest to anyone who has been
a party to or considered making an investment where any after-tax
profit is or might be dependent in part on the availability of tax
relief. See further the "effect of the restriction" and
"commentary" sections below. A key new concept introduced by the
proposed legislation is that of arrangements which "appear very
likely to give rise to a post-tax advantage". If applied more
widely in future, this concept could adversely affect a number of
current investment opportunities and concepts.
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What has happened?
The Government has announced that the Finance Bill 2009 will
include a provision to restrict the availability of tax relief for
interest paid by individuals on specified types of loans where the
availability of tax relief has the effect that the taxpayer is
virtually guaranteed to make an after-tax profit.
Draft legislation has been published for inclusion in the
Finance Bill 2009. HM Revenue & Customs (HMRC) have invited
representations on the draft legislation.
Once enacted, the new rules will apply to interest paid on or
after 19 March 2009.
The change is in response to disclosures made under the UK rules
requiring the disclosure of tax avoidance arrangements.
Who is affected?
The new rules affect individuals who claim tax relief for
interest paid on the following types of loans:
- loans to buy plant and machinery for use by a partnership or
for the purposes of an office or employment
- loans to buy an interest in a close company or in an
employee-controlled company
- loans to invest in a partnership or co-operative
- loans to pay inheritance tax
In all these situations, tax relief for interest paid is claimed
under section 383 Income Tax Act 2007 (ITA) in situations where the
general tax rules on interest deductibility would not ordinarily
apply.
The effect of the new restriction
The new restriction is aimed at schemes structured to utilise
tax relief for interest paid to ensure that the borrower investor
is virtually guaranteed to make an after-tax profit. This can arise
where, for example, arrangements give rise to a payment to the
borrower which, together with the amount of the tax relief from the
borrower's interest payments, is equal to or more than the amount
needed to meet the borrower's obligations under the loan.
The new restriction denies tax relief for interest paid where
the loan in question is made as part of arrangements "which
appear very likely to produce a post-tax advantage". A
"post-tax advantage" will arise where an amount becomes
payable to the borrower (or a connected person) or for the
borrower's benefit which, taking into account the tax relief which
would otherwise be available, equals or exceeds the borrower's
obligations under the loan. The test is applied objectively and
applies whether or not obtaining tax relief is a main purpose of
the underlying transaction.
Where the restriction applies, no interest deduction is
allowed under section 383 ITA.
If you are a party to any loans of the types listed above and
tax relief for interest paid is being claimed by the borrower,
these arrangements should be reviewed in order to ensure that the
new restriction does not apply.
Commentary
It is the "post-tax advantage" element of the new rule which is
of greatest interest. If this concept is applied more widely
in future, many investment opportunities where a tax benefit is an
important element of the investment return might be adversely
affected.
The restriction is another example of HMRC responding to
specific avoidance schemes that have been disclosed under the UK
rules requiring disclosure of tax avoidance arrangements. It
demonstrates the need to consider carefully whether any proposed
tax structuring requires disclosure and, if it does, to consider
the possibility that HMRC will change the law to prevent the
advantage sought. In this connection, the recent case of HMRC v
Mercury Tax Group [2009] is of practical importance for
compliance with the disclosure rules and is the subject of a
separate
tax briefing that we have produced.
Contact
If you would like any more information on this issue or would
like advice on your existing loan arrangements, please contact
Nick Noble, Derek Hill or Graeme Nuttall.