UK and International Tax news
Compensating Adjustments Draft Legislation
Tuesday 12th November 2013
Further to our UK Tax News article of 23 September 2013, draft legislation was published on 25 October which will restrict the availability of compensating adjustments in situations where there is excessive leveraging of companies by individuals.
The UK transfer pricing rules apply in particular where companies are overly indebted with levels of borrowing that would not have occurred at arm’s length but for the relationship that exists between the lender and borrower. The rules restrict interest deductions arising from non arm’s length debt by recalculating the taxable profit as if arm’s length arrangements had been entered into rather than the actual arrangements. Prior to the legislative change on 25 October, a compensating adjustment may be claimed by the lender so that its position mirrors that of the borrower. This effectively removes an amount of interest equal to the excess over the arm’s length amount from the charge to income tax of the lender and correspondingly from the deductible amount for the borrower.
From 25 October, such a compensating adjustment will no longer be available and instead the person receiving the interest which has been disallowed in the company is to be treated as receiving a qualifying distribution. The recipient [individual] will be entitled to a tax credit and taxed at the appropriate dividend rate [max 30.55%], which will be lower than if the receipt was taxed as interest [max 45%].
Compensating adjustments have also been available in situations involving partnerships which pay connected companies for services at cost price. Under transfer pricing rules the mark up on cost is not actually paid but still taken into account for tax purposes by the individual partners. Under the new legislation, the compensating adjustment will no longer by claimable by a person [other than a company] within the charge to income tax on the partnership profits.
The new legislation will not require a claim for the above treatment to apply, unlike under the previous legislation.
The new legislation will not apply to interest which may have been rolled up, i.e. not paid, in respect of a period before 25 October 2013 although a claim will be required for interest accrued up to this date.Contact Us