Modernising the taxation of corporate debt and derivative contracts
Response by the Chartered Institute of Taxation
1
Introduction
1.1
The Chartered Institute of Taxation (CIOT) refers to the consultation document
published on 6 June 2013 on modernising the taxation of corporate debt and
derivative contracts and welcomes the opportunity to comment on the proposals in
that document.
1.2
We have not commented on every aspect of the consultation. Where we have not
commented we should not be taken as agreeing to any of the proposals set out in
the consultation document.
2
Executive summary
2.1
The timetable is an ambitious one for the changes proposed for both Finance Bill
2014 and 2015. We would prefer to see more time taken for most of the aspects
discussed in the consultation document than is currently being proposed. This is to
ensure the changes are properly consulted upon, thought through and got right. Also
the current timetable does not take into account the very significant accounting
changes that companies are facing in 2015.
2.2
The correct starting point for profits, gains and losses of a company should be
amounts recognised as income in GAAP-compliant accounts. The tax base for
corporation tax is profits, gains and losses. These are a commercial matter of fact
and evidence, not an abstract legal phenomenon. In our view it is important to be
clear in the legislation that GAAP-compliant accounts measures of income and
expenses are determinative for corporation tax purposes, subject only to specific
statutory derogations from that principle.
2.3
We do not think the unification of the regimes for loan relationships and derivative
contracts is a priority and this should not be undertaken in 2015.
Corporate debt and derivative contacts: CIOT comments
4 September 2013
2.4
It is very important that the Disregard Regulations are retained. These rules are
required to ensure that companies (and the Exchequer) are not exposed to tax
volatility as a result of movements in the fair value of derivatives. The Disregard
Regulations are about to become more important as more UK companies move to
IFRS style accounting in the form of new UK GAAP. We suggest it will be
commercially difficult for companies to pay tax on ’paper profits’ generated by
movements in the fair value of derivatives that are used for hedging purposes where
(for whatever reason) the derivatives do not qualify for hedge accounting treatment.
3
Introduction/timetable – Chapter 2
3.1
We note the two stage process suggested and, in particular, the measures proposed
for Finance Bill 2014 in paragraph 2.18. The timetable is an ambitious one, both in
terms of the significant changes proposed in 2014 and for the wider reform in 2015.
3.2
In particular, the proposed overhaul of the detailed rules for partnerships (Chapter 9)
should not be rushed through for Finance Bill 2014. It is noted that this strand of
work is intended to be taken forward alongside the wider consultation on partnership
taxation. Although we recognise that partnerships have sometimes been used in
aggressive tax avoidance schemes, partnerships are also used in a broad range of
commercial situations as the preferred vehicle through which to conduct business.
We do not think it is helpful or correct to treat an overhaul of the rules for companies
which are members of a partnership as changes which are intended to focus on tax
leakage. Partnerships are a major area of tax law and changes will affect a large
number of taxpayers who are not involved in tax planning or avoidance and time
should be taken to get it right.
3.3
The unallowable purpose test proposals (if they are to be retained in some form)
should not be included in Finance Bill 2014. It does not make sense to change and
finalise these rules when there are still fundamental changes to the overall regime to
be introduced in Finance Bill 2015.
3.4
We also consider that 2015 is the wrong time to make significant changes to the
loan relationships and derivative contracts regimes. First, we note that HMRC are
not in a position to offer any ministerial agreement to such changes (in view of the
2015 election). Further, 2015 will already be a year of change for most companies
as they transition from ‘old UK GAAP’ to IFRS, FRS 101 or FRS 102. A stable loan
relationships and derivative contracts regime would facilitate planning for the
implications of the transition to the new accounting frameworks.
3.5
Much of the existing legislation (in particular the Disregard Regulations and the
Change of Accounting Practice Regulations) was developed painstakingly over an
extended period precisely to address the transitional issues arising from the use of
IFRS-related frameworks for financial instruments, such as FRS 101 and FRS 102.
A repeal of this legislation at this juncture seems misguided.
3.6
The proposed changes in 2015 would result in companies having to address the
corporation tax effects of transitioning to the new accounting frameworks under the
existing legislation in 2015; and, subsequently, in reflecting the corporation tax
effects of the transition to a reformed version of the loan relationships and derivative
contracts’ regimes in 2016. This does not seem sensible. It would be preferable to
retain the existing legislation relating to such transitional effects – notably the
Disregard Regulations and the Change of Accounting Practice Regulations – until
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such time that their continuing effectiveness may be appraised in the light of actual
experience of the transition.
3.7
Equally, we do not consider that it is sensible to attempt to combine the loan
relationships and derivative contracts legislation until such time as the changes
which HMRC wish to make to these regimes have been made and have been
allowed some time to ‘bed down’. Only after the rules are clear and working well
should consideration be given to whether there is any real merit in attempting to
combine the two regimes.
4
The framework – chapter 3
Purpose and scope of the regime
4.1
It is important to be absolutely clear about the operative principles of the loan
relationships and derivative contracts regimes. We think these are and should
continue to be:


The tax base for corporation tax is profits, gains and losses. These are a
commercial matter of fact and evidence, not an abstract legal phenomenon.
Accountancy evidence is respected as determinative in assessing the amount of
profits, gains and losses – subject to express statutory exceptions. Such
exceptions must be carefully scrutinised to ensure that they are fit for purpose.
The above principles inform the corporation tax treatment of profits, gains and losses
arising from, and in respect of, loan relationships and derivative contracts.
4.2
Accordingly, the relevant principle for the loan relationships and derivative contracts
regimes is that, subject to justifiable statutory derogations, profits gains and losses
on loan relationships and derivative contracts are the commercial (factual) profits
and losses evidenced by GAAP-compliant income statements.
4.3
There is no free-standing ‘legal’ concept of profit somehow underlying accountancy
measures. See Sir John Pennycuick VC’s comment on the argument that there was
a ‘distinct requirement …that the profit of a trade must be ascertained for the
purpose of income tax’ in Odeon Associated Theatres v Jones (HMIT) (1969-1973
TC 48 257 at page 274): ‘Mr. Watson, who appeared for the Crown, contended that
there is a third and distinct requirement, namely that the profit of the trade must be
ascertained for the purpose of income tax. It was not clear to me (I do not suppose
that is Mr. Watson’s fault) precisely what standard the Court should adopt, apart
from that of the ordinary principles of commercial accountancy, in arriving at the
profit of a trade for the purpose of income tax. Mr. Watson used the word ‘logic’. If by
that he intended no more than to say that one must apply the correct principles of
commercial accountancy, I agree with that, as I will explain in a moment. I think,
however, he intended to go beyond that and meant that the Court must ascertain the
profit of a trade on some theoretical basis divorced from the principles of commercial
accountancy. If that is what is intended, I am unable to accept the contention, which
I believe to be entirely novel’.
4.4
The purpose statement set out in Box 2 in paragraph 3.4 of the consultation
document is fine in so far as it goes. However, it needs to be expanded to clarify that
the ‘profits, gains and losses’ referred to are commercial profits, gains and losses
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that are ascertained in accordance with the principles set out in paragraph 4.1
above.
Subject matter of the regime
4.5
The correct starting point for profits, gains and losses of a company should be
amounts recognised as income in GAAP-compliant accounts. This is currently
recognised in the loan relationship and derivative rules – see section 307(1) and (2)
and section 595(1) and (2) CTA 2009. This could usefully be linked to the principle
that GAAP-compliant accounts measures of income are used precisely because
they are determinative of the extent to which profits, gains and losses have arisen in
respect of loan relationships and derivative contracts as a matter of observable
commercial fact. This should be recognised as (generally) a proper measure of
profit. However, the consultation document states, at paragraph 3.7, that ‘the
Government considers it important that it should be clear that, under the revised
regime, accounting treatment will not in the last resort determine whether a taxable
item exists’. In our view it is important to be clear that GAAP-compliant accounts
measures of income are or should be determinative for corporation tax purposes,
subject only to specific statutory derogations from that principle.
4.6
We would add, for completeness, that we accept that GAAP-compliant accounts
income measures may need to be modified for corporation tax purposes to ascertain
the extent to which they relate to loan relationships and derivative contracts as
distinct from other matters. This is the key function of section 307(3) and section
595(3) and we believe that this is largely the object of the discussion in paragraph
3.8 of the consultation document. However, the paragraph concludes with the
statement ‘Equally, the absence of an amount recognised in the accounts should not
mean that there is no profit, gain or loss arising from the company’s loans and
derivatives’. It may be useful to clarify that section 307(3) and section 595(3) do not
operate to bring into account debits and credits that are not recognised for
accounting purposes. (This is not to say that credits and debits are not to be brought
into account via other specific statutory provision – for example, section 446 CTA
2009.)
Measurement and timing
4.7
Inclusion of amounts recognised in respect of loan relationships and derivative
contracts in GAAP-compliant income statements and the exclusion of amounts
appearing in other financial statements such as reserves (together ‘the general rule’
hereafter) is the correct starting point, applying the principles described in paragraph
4.1 above. Critically, amounts recognised in respect of loan relationships and
derivative contracts otherwise than in such income statements should not be
included in prima facie profits. This point was made to HMRC in previous
consultations regarding the adaptation of the loan relationship and derivative
contract regimes for the introduction of IFRS, but not accepted at that time – see the
reference to ‘true representation’ in http://www.hmrc.gov.uk/accountingstandards/int_accounting.htm#1. We would reiterate our view that restricting
inclusion to amounts that are recognised in GAAP-compliant income statements
constitutes a highly effective anti-avoidance rule in and of itself, as it correctly
focuses the computation on the true tax base.
4.8
Where appropriate, the position given by the general rule may be modified pursuant
to carefully considered statutory derogation. Examples of such derogations would be
transfer pricing, the application of the connected companies’ relationships and the
intra-group continuity rules. A more telling example is Regulations 7 to 9 of the
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Disregard Regulations which operate to reduce or eliminate tax volatility in the case
of inefficient or undesignated hedging arrangements – in order to avoid the
incidence of potentially large-scale ‘dry’ tax charges. In the previous consultations
regarding the adaptation of the loan relationship and derivative contract regimes for
the introduction of IFRS this was as agreed as an appropriate and justifiable
derogation from the general rule.
Tax and accountancy
4.9
Paragraph 3.11 suggests that the accounting treatment may not capture ‘the legal
forms of certain items of income’. This seems to be incorrect in principle.
Fundamentally, income from loan relationships and derivative contracts is a
commercial matter of fact, not some underlying legal concept.
4.10 Paragraph 3.12 refers to amounts claimed as losses as a result of the derecognition
of loan relationships and derivative contracts. It is important to be clear about this:
losses recognised on the derecognition of loan relationships and derivative contracts
in the income statements of GAAP-compliant accounts are, and should be,
deductible in principle – and gains should be chargeable; a loss arising on the
disposal of a loan relationship is a commercial loss. We suspect HMRC may be
referring here to amounts not recognised in the income statement but elsewhere,
under the existing legislation. We reiterate: restricting inclusion to amounts that are
recognised in GAAP-compliant income statements constitutes a highly effective antiavoidance rule in and of itself, as it correctly focuses the computation on the true tax
base.
4.11 Paragraph 3.13 refers to a case ‘where accounting rules have been correctly
applied, but the result is nonetheless incompatible with the intention of the rules’. In
our view the general principles described above need to be clearly stated in the
legislation to prevent propositions of this kind from being advanced. The subject
matter of the regimes should be – precisely – commercial profit as evidenced by
GAAP-compliant income measures. Any derogations from the general principles
whether for technical or policy reasons need to be carefully examined and justified.
4.12 Paragraphs 3.14 to 3.22 of the consultation document refer to the relationship
between GAAP-compliant accounts measures of income and the computation of
profits gains and losses for corporation tax purposes in respect of loan relationships
and derivative contracts. We have already referred to the key function of section
307(3) and section 595(3) of the regimes in attributing the accounts data given by
section 307(2) and section 595(2) to profits and losses arising from and in respect of
loan relationships and derivative contracts. It would be helpful to clarify this key
function in the legislation. In practice, HMRC have attempted on occasion to import
an anti-avoidance function into section 307(3) and section 595(3) that is foreign to
this essential purpose. HMRC are proposing a ‘general’ TAAR in respect of the
regimes. A subterranean general TAAR should not be conflated with the general
computational rule described above as this will simply detract from the coherence of
the rules. It leads to the kind of circularity that is discernible in the discussion in the
section of the consultation document entitled ‘Tax and accountancy’.
4.13 Accordingly, in our view the approach described in paragraphs 3.14 to 3.22 is
misconceived and incoherent. If GAAP-compliant accounts measures of income are
not used to quantify the amount of commercial profit arising from, and in respect of,
loan relationships and derivative contracts, then the alternative would appear to be a
kind of ‘tax GAAP’ – alternative ‘accounting’ rules for tax purposes that would be
determinative, in the way that GAAP accounting is determinative, of the existence
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and extent of the attributable commercial profits, gains and losses. The creation of
such a framework would constitute an enormous undertaking, and would seem to
have no real benefit, given the rigour and authority of existing GAAP. Businesses
would be subject to two comprehensive codes for accounting for the whole range of
loan relationships and derivative contracts; that would be too onerous.
4.14 If HMRC’s proposition is that the tax base is not the commercial profits gains and
losses arising in, and in respect of, loan relationships and derivative contracts, then
we strongly disagree. In our view this is contrary to Parliament’s intention in
establishing the regimes.
4.15 Where GAAP-compliant income measures are justifiably not regarded as
appropriate, having regard to some specific over-riding policy, then it is the role of
carefully-considered statutory derogations from the general rule to modify the
aforementioned accounting measures.
4.16 The key to ensuring success of this approach is for the legislation to be very precise
in its specification of when a deviation from the default position of what is in the
accounts is required. It must be much more than just a 'purposive guide' to the
interpretation of the legislation - so for example in Category I (Deem different facts)
in paragraph 3.33 an alternative set of facts would be deemed to apply only in the
circumstances specified in the legislation. Without this clarity, a taxpayer will not be
able to assume that HMRC's interpretation of the position will match its own. For
protection of both the taxpayer and the Exchequer, neither should be able to deem
alternative facts without a specific legislative provision.
4.17 Paragraph 3.22 talks about 'guidance' being sought in case law where the new
legislation is not sufficiently clear. In our view this is not an acceptable approach.
The legislation should be created with sufficient certainty on its own terms. It is not
acceptable to create legislation with inbuilt uncertainty such that it is expected to be
necessary to routinely seek clarification in HMRC guidance or case law, or even
necessary to seek such clarification only in boundary cases. To do so creates the
opportunity for HMRC to legislate by guidance without reference to, or scrutiny by,
Parliament. There must be clarity of provisions within the legislation.
5
Looking behind the accounts – Chapter 4
5.1
Paragraph 4.3 gives a number of examples where ‘amounts that relate to matters
that fall to be taxed under the loan relationships and derivative contracts tax regimes
may not be readily visible in a company’s accounts’. In our view this statement
proceeds from an assumption that the subject matter of the loan relationships and
derivative contracts regimes is other than the commercial profits gains and losses
arising from or in respect of loan relationships and derivative contracts as
determined from GAAP-compliant income measures, with which we disagree.
We would comment on the examples given as follows:

‘The effects of more than one instrument may be combined as if they were a
single instrument or vice versa’. This is an issue of attributing the section
307(2)/section 595(2) accounts data to the relevant loan relationships and
derivative contracts for an accounting period. This is the essential function of
section 307(3) and section 595(3), as previously described. We do not
consider that this computational process causes undue difficulty in practice
(except where HMRC seek to import an anti-avoidance function in the case
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



4 September 2013
of some planning arrangements). We do not consider that any change to the
provision is necessary, save for clarifying its essential purpose. Disputes may
ultimately be resolved as factual questions by the tribunal, as at present.
HMRC’s anti-avoidance agenda is best served by anti-avoidance legislation;
‘An instrument or amounts relating to an instrument may simply not be
recognised’. Where this is the outcome given by GAAP-compliant accounts,
the starting point should be that this is what is to be followed for corporation
tax purposes. A statutory derogation from that principle may be justified in
certain circumstances on the basis of some over-riding policy – as currently
provided in the case of certain arrangements involving non-recognition of
financial instruments and returns on those instruments;
The third bullet point is best addressed in the context of the separate
discussion relating to partnerships;
The fourth example refers to OCI, and recycling. Again, the starting point
should be that GAAP-compliant income statements (excluding OCI) are
followed for the purposes of the regimes. Any derogation from this general
rule will need to be carefully examined and justified; and
Finally there is a reference to netting in the income statement. We question
whether there is any problem here that is not satisfactorily addressed by the
correct application of section 307(3) and section 595(3).
5.2
The cases where a departure from GAAP-compliant accounts measures may be
justified will need to be scrutinised very closely on a case by case basis in order to
avoid the regime becoming incoherent. Paragraph 4.8 refers to ‘the economic profit
or loss from those instruments’. We reiterate – the best evidence of the existence
and extent of profit will be accountancy evidence of commercial profit. A reference to
an ‘economic’ concept that is somehow different from the evidence of commercial
accounting seems redundant, and will need to be articulated in greater detail.
5.3
We suggest that the application of any rule along the lines of paragraph 4.21 should
be limited to cases where the items to which the accounting treatment has regard
are not themselves taxed or relieved at all; or if they are, not by reference (as a
starting point) to the accounting treatment.
6
Accounting issues – Chapter 5
6.1
We broadly support the approach of Chapter 5 and do not have strong views on the
terminology. As mentioned above, in our view, the amounts in the profit and loss
account/income statement should be the primary reference point for both amounts
and timing.
6.2
The areas mentioned, for example OCI amounts, which are not required to be
recycled to the profit and loss account/ income statement should be items dealt with
as 'deviations from default' as discussed in relation to Chapter 3 above – where this
is justifiable.
6.3
We agree that amounts recognised in a company’s profit and loss account or income
statement should constitute the primary reference point for the measure and timing
of amounts under the loan relationships and the derivative contracts regimes.
6.4
We also agree that amounts taken to OCI should not be brought to account for the
purposes of the regimes until (broadly) such time as the amounts are recycled to the
income statement/ profit and loss account. Any derogation from this rule will need to
be carefully scrutinised. We do not accept a general principle that amounts that are
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not ultimately recycled, in respect of loan relationships and derivative contracts,
should be brought into account. A position that amounts should be charged where
they do not constitute profits and losses in commercial accounting terms will require
justification in each case.
6.5
In general terms, we prefer the clarity of designating relevant income statements
rather than referring to amounts recognised ‘in profit or loss’.
6.6
Perpetual debt and regulatory capital are areas of concern for insurers and others in
the financial services sector. The consultation document refers to those matters as
far as they relate to the banking sector but does not appear to acknowledge the
impact in other areas. We understand that the ABI has raised this point with HMRC
and is submitting a separate paper on it to explain the concerns for insurers.
Broadly, we understand the issue to be that insurers are issuing perpetual debt
instruments more frequently in response to the Prudential Regulatory Authority’s
requirements that Tier 1 and Tier 2 instruments should be aligned with draft
Solvency II requirements (which requires them to be perpetual instruments). If the
coupons on these instruments are not treated as debt, and so are not deductible for
tax purposes, this will have significant consequences for insurers.
7
Unified regime for loan relationships and derivative contracts – Chapter 6
7.1
We think it is unrealistic to think in terms of combining of the loan relationships
legislation and the derivative contracts legislation in Finance Bill 2015, at the same
time as making significant changes to the two regimes. By way of analogy it took
some two years for the loan relationships legislation and the derivative contracts
legislation to be rewritten into CTA 2009. To conduct this exercise HMRC had a
team of three full-time inspectors together with a dedicated drafting team. Further,
there was a ‘committee of experts’ who reviewed the draft clauses as and when they
were produced and before they were released for comment. Nevertheless, one of
our members, when preparing a commentary on the rewritten legislation in the
winter of 2008/09, identified errors that had ‘slipped through the net’ that required 21
Committee Stage amendments. If HMRC proceed with trying to combine the
regimes in its current timetable it may find that it creates a number of opportunities
for tax planning; where legislation is being changed, there can be no guarantee that
advisers will feel obliged to point out ‘errors in the taxpayers favour’ to HMRC.
Indeed, such errors may only be spotted once the legislation has been enacted as
most advisers in 2015 will be focusing on the tax implications arising from the
transition to the new accounting regime, given that the majority of UK companies will
face this transition in 2015.
7.2
We consider the sensible approach would be to make such changes as are
considered necessary to the loan relationships legislation and the derivative
contracts legislation, to allow such changes to ‘bed down’ and only then consider
whether there is any merit in combining the two regimes.
7.3
Instead of rewriting the two regimes, another approach would be to ensure the two
regimes apply to catch transactions which potentially straddle the two regimes and in
such cases that the two regimes operate on a joined up basis. In our experience this
is what is happening in practice.
8
Connected party debt - Chapter 7
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8.1
We refer to paragraph 7.3 and the reference to the rules being to prevent the
exploitation of asymmetries. However, our understanding is that the rules are also
meant to prevent asymmetries. That the rules operate symmetrically should be a
fundamental principle.
8.2
It is not clear to us what is being proposed in Option 2, which we note is the
Government’s preferred option. It appears to be suggesting an asymmetrical
approach with releases of connected party debt being taxed in the hands of a debtor
and yet creditors being denied relief for impairment and credit losses. Please clarify
exactly what HMRC have in mind as regards Option 2 and why HMRC are favouring
this asymmetrical approach. Without further explanation and arguments in its favour,
given that Option 2 is asymmetrical in its approach, we strongly oppose this option.
8.3
Our members are strongly in favour of retaining the current symmetrical approach to
connected party debts if the intention is that under the revised proposal a creditor
will continue to be denied relief for impairment losses.
8.4
It is also not clear from Option 1 quite what is being proposed and which of the
issues identified this option is intended to address. We would welcome a further
discussion of the issues in paragraph 7.6 in the context of the structure of the
revised legislation generally and to consider other options that may be available.
8.5
Any of the changes proposed may have a significant effect on taxation of groups of
companies. This area should be the subject of a wider discussion and not confined
to Working Group 2. We would be happy to have a separate meeting with you to
explore exactly what HMRC have in mind as regards changes to the connected
party debt rules.
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Intra group transfers (group continuity) – Chapter 8
9.1
We consider that the intra-group continuity rules are required in order to protect the
Exchequer from the risk of losses being triggered as a result of intra-group transfers
in circumstances where a loss would not otherwise have arisen: for example, where
a transferor is accounting for a loan relationship on an amortised cost basis of
accounting and it transfers the loan relationship to another group company. In such
circumstances we think that the existing rules serve to protect the Exchequer against
the accelerated recognition of a loss (where the loan relationship standing at a loss)
and a tax payer (where the loan relationship is standing at a gain).
9.2
We consider that, over the years, HMRC have introduced a series of anti-avoidance
measures which, as far as we are aware, are serving to prevent the intra-group
transfer rules from being abused. Further strengthening of the anti-avoidance
provisions is not required. However, the architecture of the rules could be improved.
9.3
The intra-group continuity rules in Chapter 4, Part 5 and Chapter 5, Part 7 CTA 2009
operate by prescribing a transfer price that prevents the acceleration of gains and
losses for the transferor on the transfer. There is no detailed provision in relation to
the manner in which the loan relationship and derivative contracts legislation should
apply to a loan or derivative that has been transferred in the hands of the transferee
after the transfer. Typically the ‘tax’ transfer price will differ from that used for
accounting purposes. The intra-group continuity rules do not prescribe how profits
and losses on the loan or derivative should be brought into account computationally
after the transfer. For instance, it is sometimes argued that, as IFRS and the UK
accounting frameworks that are related to IFRS, require financial instruments to be
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recognised initially at fair value, the correct application of the intra-group continuity
rules entails the recognition, for corporation tax purposes, of a profit or loss on
acquisition by the transferee. Most advisers, however, take the view that the profits
and losses should be determined as if the tax transfer value were the value at which
the loan or derivative was carried in the transferee’s accounts. The adoption of the
argument mentioned above might lead to the acceleration of gains and losses
contrary to the policy underlying the rules. We suggest the operation of the rules in
this area should be clarified.
9.4
The degrouping rules should be amended so they apply in circumstances where a
loss would arise as a result of the deemed degrouping disposal. This would protect
against abuse since it would ensure that any loss is crystallised prior to a transfer
and thus ensure that it is subject to the change in ownership anti-avoidance
legislation, whilst ensuring that a ‘fair’ result is achieved where the company that is
being sold has received a transfer of a number of the loan relationships and/or
derivative contracts, some of which are standing at again and some of which are
standing at a loss.
9.5
With regard to Option 1 paragraph a) seems to be acceptable. We are less sure
about paragraph b). If only the transferee is using fair value accounting (and the
transferor is not) and the asset is standing at a loss, then a loss will arise - is this
what HMRC want? We agree with paragraphs c) and d). However, we think our
suggested approach above is preferable to Option 1.
9.6
We are struggling to see the benefits of Options 2 or 3. This is because, as a
general principle of tax, intra-group transfers should not trigger a tax liability on
transfer. Could the reasons given as to why Options 2 or 3 may be HMRC's
preference be adequately addressed through clear legislative provisions over
matters that require deviation from the default position (chapter 3 comments).
9.7
In specific response to question 8.3, our view is that it is fundamental from a
commercial perspective that intra-group transactions should not of themselves
create a charge to tax. This should be respected as a general principle of tax law.
9.8
Please could you clarify the reference at paragraph 8.14 to overriding the transfer
pricing rules? This seems to be unhelpful and to introduce uncertainty.
There is a lack of clarity in the proposals set out in the consultation document and it
may be helpful for our members to have a meeting with you to explore exactly what
is being proposed.
10
Partnerships and transparent entities – Chapter 9
10.1 Although, on the face of it, much of this chapter reflects a sensible approach, it
seems strange to overhaul the treatment of partnership loans and derivatives ahead
of the treatment of partnerships generally. The wider consultation on partnerships is
still ongoing. As noted in the consultation document there are ongoing separate
consultations on two aspects of partnership taxation, disguised employment through
LLPs and tax advantages resulting from certain arrangements involving allocation of
profit and loss, however, we understand that more is expected in this area. The
Office of Tax Simplification is also currently looking at partnership taxation.
Consequently, as mentioned above, we are strongly of the view that any changes in
this area should not take place until, at least, Finance Bill 2015.
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10.2 It is also clear that the thinking in this area is at an early stage and the options
presented are very broad and general in their scope. In particular paragraph 9.24
asks a very fundamental question regarding the basis for ascertaining each partner’s
share in the partnership’s loans and derivatives. Addressing this question may
remove the need for more radical change. Until basic questions such as this are
addressed, reform is, and should be, a long way off.
10.3 It is also important that there should be wide consultation on this aspect of the
proposals, as well as the work to be undertaken by Working Group 2. Changes in
this area will have a significant impact across the corporate sector.
11
Exchange gains and losses and hedging – Chapter 10
11.1
It is very important that the Disregard Regulations are retained. These rules are
required to ensure that companies (and the Exchequer) are not exposed to tax
volatility as a result of movements in the fair value of derivatives held for hedging
purposes. We are aware that some major companies that use derivatives to hedge
forecast transactions and firm commitments do not consider that they will be able to
achieve hedge accounting under the new accounting standards and therefore they
need Regulations 7, 8 and 10 of the Disregard Regulations to be retained. The
retention of Regulations 3 and 4 and the related regulations will also be vital as
under the revised accounting standards it is not possible to take exchange
movements on a loan relationship or derivative contract that is used to hedge an
investment in a subsidiary to reserves in a company’s own (as opposed to
consolidated) accounts.
11.2
We have consulted with advisers who act for smaller companies. The universal
concern we have heard expressed is that smaller companies may not be able to
achieve hedge accounting for accounting purposes (for one reason or another).
Consequently, the overwhelming response we have received is that the Disregard
Regulations should be retained.
11.3
There is a strong demand for a change to the ‘opting out’ deadlines. Advisers acting
for smaller companies may only discover that a company is using a derivative as a
hedge when they start to prepare the company’s tax computation. As a result of this
the preference would be that the deadline for a company electing out of Regulation
9 (and also Regulations 7 and 8) should be moved to 12 months after the end of
the company’s first accounting period for which it first begins to account for
derivatives on a fair value basis (to allow for cases where a company begins to use
derivatives later than 2015).
11.4
The Disregard Regulations are required to prevent tax charges arising as a result of
volatility in companies’ profit and loss accounts where hedge accounting cannot be
achieved or is ineffective for corporation tax purposes. The Disregard Regulations
are about to become more important as more UK companies move to IFRS style
accounting under new UK GAAP. We suggest it will be commercially difficult for
companies to pay tax on ’paper profits’ generated by movements in the fair value of
derivatives that are used for hedging purposes where (for whatever reason) the
derivatives do not qualify for hedge accounting treatment or the hedge relationships
are ineffective for corporation tax purposes.
11.5
To the extent that it is considered that taxpayers are having difficulty in
understanding the Disregard Regulations consideration could be given to amending
some of the regulations to ensure they refer to the current re-written legislation.
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Corporate debt and derivative contacts: CIOT comments
4 September 2013
Further clarification could also be achieved by HMRC expanding its guidance. From
the discussion we have had with representatives from smaller firms, they have no
difficulty with the concept of continuing to follow an accruals basis for the profit
recognition in respect of derivatives.
11.6
We recommend that any changes in the area of exchange gains and losses (as
well as hedging) should be deferred and considered as a subsequent piece of work
to any changes that are made in 2014 or 2015. The current foreign exchange rules
are familiar to companies and advisers. Consequently we do not support changing
a regime which works well in practice at a time when it is not clear how changes
would work and in view of the imminent upheaval in accounting practices.
11.7
If there are specific areas of concern to HMRC then it would be preferable for
HMRC to identify the ‘abuses’ it wishes to target, rather than making sweeping
changes to the basis on which foreign exchange movements are recognised.
12
Debt restructuring – Chapter 11
12.1
Paragraph 11.18 of the consultation document (Option 1) proposes that section
322(4) CTA 2009 should be restricted to situations along the lines of the
exemption in Section 361A.
12.2
Alternatively, paragraph 11.20 (Option 2) proposes a restriction by reference to an
arm's length requirement.
12.3
We are not in favour of either Option 1 or 2. Option 1 has some practical issues
and Option 2 is not workable in practice. Accepting shares with a lower market
value to the face value of the relevant debt is not an obviously ‘arm’s length’
action. In our view it would create enormous difficulties. In the context of
consensual restructuring of troubled debt, it will always be difficult for principals
and their advisers to be comfortable that transactions are necessarily arm’s length.
This option is a recipe for greater uncertainty and the submission of a higher
number of clearance applications.
12.4
We would like to suggest an alternative approach. One of the key aims of the
changes in respect of debt restructuring is to reduce the volume of non-statutory
clearance applications. We set out below some suggestions for the amendment of
the statutory regime in order to provide greater certainty in respect of the
corporation tax treatment of debtor relationship releases in the context of corporate
rescue; and thereby to reduce the number of cases requiring the advance
clearance of HMRC.
Introduction of relief for release of debtor relationships pursuant to
corporate rescue arrangements
12.5
We suggest that what is required is to extend the relief in section 322 CTA 2009 to
cover a release of a debtor relationship pursuant to bona fide corporate rescue
arrangements. We suggest the introduction of a new Condition D, in section 322,
which would resemble the form of Condition C but which would not require a
formal insolvency process currently to exist. Instead, new Condition D would
depend upon the existence of appropriately defined corporate rescue
arrangements.
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Corporate debt and derivative contacts: CIOT comments
4 September 2013
12.6
The definition of corporate rescue arrangements will require the input of advisers
with knowledge and experience of these transactions. In our view the definition of
corporate rescue arrangements should address the condition of being insolvent
rather than addressing the probability of formal insolvency processes.
12.7
We do not consider that this should be open to abuse in practice. Accordingly, we
do not consider there is a need to test for an arm’s length transaction or to include
a TAAR; and we consider that including either or both of these would be counterproductive. We will be pleased to discuss the definition of corporate rescue
arrangements further with you, as required.
12.8
It is also crucial that section 322(4) is retained. This is needed to ensure that there
is a relief available for boundary cases which do not clearly fall within the scope of
the definition of corporate rescue arrangements. We suggest that the existing
provision is retained as it is. Taxpayers and advisers understand how it works in
relation to consensual debt restructuring. This, together with the general
exemptions amended as suggested, should reduce clearance applications.
Amendment of corporate rescue exception in section 361A
12.9
The corporate rescue exemption in section 361A should be amended to
incorporate a definition of corporate rescue arrangements as described above.
Introduction of corporate rescue exception in section 362
12.10 We would suggest that a corporate rescue exception along the lines of section
361A (amended as above) is introduced into section 362. We are aware of cases
where the potential application of section 362 has hindered proposals to refinance
companies in financial distress. In our view, section 362 should also include a
corporate rescue exception along the lines of section 361A, but addressing section
362 circumstances. This should also operate as a safe harbour relative to section
363A.
Introduction of relief in section 358 for release of relevant rights arising from
corporate rescue arrangements
12.11 The utility of the corporate rescue exception is circumscribed by the dis-application
of sections 322(4) and 358 in the case of a subsequent release of ‘relevant rights’
(ie rights acquired in circumstances where section 361A or section 361B has
applied). The exclusion of section 361A ‘relevant rights’ from sections 322(4) and
358(2) would facilitate troubled debt restructurings by removing an obstacle to a
subsequent intra-group financial reconstruction of the debtor company.
12.12 This might be achieved by deleting the words ‘the corporate rescue exception or’
in section 358(4).
13
Hybrids and ‘special treatment’ instruments – Chapter 12
13.1
We consider that the current rules dealing with derivatives that are embedded in
creditor relationships will wither on the vine as a result of the accounting changes
that are being proposed. Once it is no longer permissible for a company to
bifurcate a creditor relationship for accounting purposes, the rules would cease to
apply
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Corporate debt and derivative contacts: CIOT comments
4 September 2013
13.2
We consider that the existing treatment for issuers of convertible and exchangable
securities should remain unchanged.
14
Anti-avoidance measures – Chapter 14
14.1
As mentioned above, we suggest that any changes to the unallowable purpose
rule are postponed until Finance Bill 2015 to coincide with the bulk of the changes.
It is only once these are becoming clearer that it will be possible to properly assess
the unallowable purpose rule.
14.2
We question whether an 'unallowable purpose' test continues to be necessary
in the loan relationship and derivative contract rules. We believe that if the GAAR
is applied correctly then that should be adequate to capture any abusive
transactions. When the GAAR was introduced it was intended to provide an
overriding principle of purpose - if a transaction is done for a tax advantage with no
clear commercial purpose then it is in danger of being caught by the GAAR. The
GAAR was also introduced with the promise of simplification, a move away from
future TAARs and a possible reduction of current ones. The proposals to retain,
and enhance, the unallowable purpose rule for loan relationships seems contrary
to this.
14.3
Regarding the ‘regime TAAR’, we also question whether this is really necessary.
Since this is intended to ‘fit with the ... [GAAR]’ (paragraph 2.11) why is a further
layer of anti-avoidance measure required? We suggest that the Government is
fighting a battle which has already been largely won; as a result of the GAAR and
also the changes proposed to the regime overall.
15
Other comments
15.1
Although the consultation document says that there is no intention to change the
definitions of loan relationship or derivative contract, this consultation ought not to
pass up the opportunity to think about whether any changes are in fact needed.
15.2
For example, it should be made clear the case that debts arising where one
company bears expenses for the account of another on the basis that it will be
reimbursed from the second should clearly be treated as arising from a lending
transaction. Such cases arise frequently within corporate groups, where treasury
functions and banking relationships are often positioned within a small number of
group companies. Treating such advances as loans was a position accepted by
HMRC in practice before the decision of the first tier tribunal in MJP Media
Services Ltd, and could be justified by reference to the definition of ‘loan’ in section
476(1), CTA 2009. This decision, however, has caused uncertainty, and it would
be helpful to put the matter beyond doubt in the legislation.
15.3
Another example of a definition which could be looked at is contract for differences
(CFD) – this is not always easy to apply in practice. Some aspects of the definition
of ‘contract for differences’ are somewhat obscure. The reference to a ‘pretended’
purpose derives from the origin of the definition of a CFD in the regulatory
legislation, and has a specific meaning which is not obviously relevant in a
corporation tax context. More importantly, the definition refers to a purpose of
making a profit or avoiding a loss by reference to fluctuations. On occasion certain
HMRC officials have sought to argue that the definition requires that the intention
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Corporate debt and derivative contacts: CIOT comments
4 September 2013
of one party to the contract is to make a profit, whilst that of its counterparty should
be to avoid a loss.
15.4
However, the term ‘avoid a loss’ does not refer to a loss on the contract itself. It
refers to the contract’s purpose being to avoid a loss on an underlying item (ie the
hedged item) which the contract is hedging; the phrase is only appropriate in the
context of a hedging contract1. It would be useful to put this beyond any
reasonable doubt.
16
The Chartered Institute of Taxation
16.1
The Chartered Institute of Taxation (CIOT) is the leading professional body in the
United Kingdom concerned solely with taxation. The CIOT is an educational
charity, promoting education and study of the administration and practice of
taxation. One of our key aims is to work for a better, more efficient, tax system for
all affected by it – taxpayers, their advisers and the authorities. The CIOT’s work
covers all aspects of taxation, including direct and indirect taxes and duties.
Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular
focus on improving the tax system, including tax credits and benefits, for the
unrepresented taxpayer.
The CIOT draws on our members’ experience in private practice, commerce and
industry, government and academia to improve tax administration and propose
and explain how tax policy objectives can most effectively be achieved. We also
link to, and draw on, similar leading professional tax bodies in other countries. The
CIOT’s comments and recommendations on tax issues are made in line with our
charitable objectives: we are politically neutral in our work.
The CIOT’s 16,800 members have the practising title of ‘Chartered Tax Adviser’
and the designatory letters ‘CTA’, to represent the leading tax qualification.
The Chartered Institute of Taxation
4 September 2013
1
This was highlighted in City Index Ltd v Leslie [1992] AC 98 where Elizabeth Gloster Q.C and Michael Ashe cited ‘The
wording of the phrase [ie to avoid a loss] is composite and describes the activity of hedging’. Additionally, the decision of
Leggatt in City Index Ltd v Leslie was to reject the proposition that the phrase ‘secure a profit’ also referred exclusively to
hedging contracts. Leggatt’s decision was that the phrase to ‘secure a profit’ connoted making a profit, thus the expression
‘secure a profit or avoid a loss’ addressed speculative and investment contracts as well as those entered into for hedging
purposes.
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