The measure
A discussion document has been released proposing a new 'principles-based' anti-avoidance approach to transactions that involve loan relationships and derivatives that give rise to 'group mismatches' - ie where a transaction gives rise to an asymmetry (tax deductible losses versus non-taxable profits) between companies in the same group.
This is a response to the number of schemes notified to HMRC under the tax disclosure rules in respect of loan relationships and derivatives which involve a mismatch between the taxation of two group companies. This tax asymmetry potentially gives rise to a tax advantage for the group where there is no overall corresponding economic loss.
To date HMRC's approach has been to introduce a series of complex legislative changes to counteract these schemes one by one. Today's proposal is to introduce principled-based legislation mirroring the approach of the disguised interest and transfer of income stream rules which are perceived to have been an effective way of tackling anti-avoidance.
In the discussion document, HMRC have outlined how a generic approach to counteracting asymmetric avoidance could operate. In particular, the rules could apply where:
- there is a 'tax mismatch arrangement' between connected companies;
- it would be reasonable to assume that the arrangement was designed to secure, either:
-
- a reduction in the group's tax rate as a result of asymmetric treatment of a loan or derivative; or
- a possible reduction in the group's effective tax rate as a result of a contingency (e.g. currency movements or another index), unless that contingency gives rise to an equivalent likelihood of an increase in the group's tax rate.
HMRC identifies that there are a number of solutions that could
address such asymmetry (eg the exclusion of debits and credits,
imposition of further debits and credits, or otherwise cancelling
the UK tax advantage). This detail is expected to be worked through
as part of the consultation process.
A key question to be considered as part of the consultation is
whether this legislation should impact only UK-UK transactions or
be extended to cover cross border arrangements. It will also be
expected to cover the possibility of repealing various targeted
anti-avoidance rules including, potentially, the arbitrage rules
(or part thereof). HMRC also welcome input into whether this
principle based approach would be effective, the scope of any such
rule (eg whether it should be wider than UK-UK transactions, and if
so, how), and whether it is appropriate to include a purpose test,
or express exclusions.
Who will be affected?
Potentially all UK corporation tax payers.
When?
Comments on the discussion document are requested by 31 May 2010. A workshop is proposed to follow in June or July 2010 and draft legislation will be released as part of the 2010 Pre-Budget Report for introduction as part of the Finance Bill 2011.
Our view
We agree with the approach to simplify what is an increasingly
complex area with a growing body of targeted anti-avoidance
legislation. However, the devil will be in the detail. The
comprehensive consultation process which accompanied the recent
disguised interest and transfer of income streams rules resulted in
extensive changes to the initial proposals and it will be essential
to consult widely to ensure that commercial transactions are not
affected and that it is possible for taxpayers to obtain
certainty.
One of the effects of the new debt cap regime (another complex set
of rules) is to severely limit the types of group mismatch
opportunities generally, so we would also question whether another
reform process is actually needed.
Although HMRC are clear that they wish to establish symmetry within
groups, it is disappointing that they do not appear to have
defined, or limited this beyond, a principle of symmetry. The
difficult questions and issues will be both those that they have
identified for further discussion and those which cannot be
identified until a clearer definition and scope has been
identified. To ensure that these proposed rules do not act as
another deterrent to international business being conducted with
the UK, HMRC should ensure that it sets out a framework and clear
scope early in the process.
The discussion document sets out that its aim is to ensure that it
is only UK tax advantaged schemes that should be caught, and that a
purpose test or specific exclusions might be appropriate. We agree
that there need to be exclusions for commercial transactions.
However, the initial suggestion of a test that is based on whether
it would be reasonable to assume the arrangement is designed to
reduce the group's tax rate is concerning.
Firstly, the inclusion of an 'objective purpose test'
should be resisted unless there is a comprehensive clearance
process (which the arbitrage rules currently provide). Secondly,
this introduces a new legislative measure of how you measure a
group's tax rate. In addition it appears that the question of
whether there is an increase in the rate of tax requires a
'counterfactual' assumption. This inevitably is a
subjective matter and is likely to give rise to disagreement
between taxpayers and HMRC. Hopefully, in the pursuit of
simplification, this new measure will not increase uncertainty and
add to the compliance complexities for the taxpayer.
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