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Technical Note On Corporate Debt And Derivative Contracts

Wednesday 16th April 2014

HMRC has recently issued a Technical Note – Modernising the Taxation of Corporate Debt and Derivative Contracts – which provides an update on the consultation document issued in June 2013.

In the 2013 Budget, the Government announced consultation on a package of proposals to modernise the corporation tax rules governing the taxation of corporate debt and derivative contracts, with a view to legislating in the 2014 and 2015 Finance Bills.

The current rules for the taxation of corporate debt (loan relationships) date from 1996. A separate regime for derivative contracts was introduced in 2002. They are based on the concept of deriving the taxation of profits and losses on these instruments from accounting entries. They do however incorporate some highly complex features, particularly around debt held between connected companies and within groups.

The Government has received frequent adverse comment on the complexity of the current rules. The regime for both loan relationships and derivative contracts has developed significantly over time, evolving in response to emerging avoidance risks and to changes in commercial and accounting practice.

Accountancy standards, on which the tax rules are based, have not remained static. Standard setters for both UK GAAP and International Financial Reporting Standards (IFRS) are now in the final stages of a process, begun in 2009, of reviewing and revising accounting treatments for financial instruments, with revised standards expected to be finalised in 2014. Adoption of these new standards will take place over the next few years and should cement the accounting treatment for some time.

Historically, the complexity in the loan relationships and derivative contracts regimes has consistently provided opportunities for attempts to avoid tax. Reactive measures to counter this avoidance have contributed to further complexity and to some loss of structural clarity in the regime, tending to leave further potential loopholes. This growing complexity has increased compliance costs for some businesses and has made it difficult in some cases for compliant groups and companies to be certain about tax treatments, undermining the international competitiveness of the UK tax system. At the same time, however, the rules do operate without difficulty for many, particularly for smaller companies with straightforward financing arrangements, which do not engage the more complex areas of the regime.

The Government launched a review of these rules last year with the intention of exploring and, where necessary, addressing these issues. HMRC has been consulting businesses, representative bodies, advisers and other interested parties since June 2013 and a summary of responses to the consultation document was published in December 2013.

Some legislation, making adjustments to the rules on ‘bond funds’ and ‘degrouping’, has been included in the 2014 Finance Bill.

The Technical Note provides an update on the Government’s thinking on the subject and sets out priorities to be addressed by legislation to be included in the 2015 Finance Bill and, in some cases, by way of secondary legislation. It is expected that these measures will generally have effect for accounting periods commencing on or after 1 January 2016, although some, particularly anti avoidance measures, may need to apply earlier.

A further formal consultation document is not being issued but the Government has stated that it continues to welcome views and input on issues considered in the Technical Note.

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