HM REVENUE & CUSTOMS (HMRC) RECENTLY published the consultation document 'Changes to corporation tax rules on late payments of interest between connected companies' (Revenue & Customs Brief 33/08). It has acknowledged that recent decisions of the European Court of Justice (ECJ) have questioned whether the current rules concerning late payments of interest between connected companies are compatible with the principles of European Community law, which legislate against non-discrimination.
Consequently, HMRC has been proactive in announcing changes to these rules and has invited companies, their advisers and representative bodies to comment on the options set out in the consultation document with a view to developing draft legislation to change the rules.
CURRENT LATE-PAID INTEREST RULES
Generally, for corporation tax purposes, the taxation of profits and losses on loans are taxed or relieved in line with the company's accounts. However, these rules are modified in the case of loan relationships between connected companies.
Under these rules, a debtor company will only get relief for interest on a paid basis rather than in accordance with its accounts, where interest payable to a connected party accrues but is not paid within 12 months following the end of the accounting period, and the creditor is not taxed on an accruals basis on that amount. 'Connected' here takes its meaning from s87 of the Finance Act 1996 and applies where one company controls the other or where both companies are controlled by the same person.
HMRC has been challenged on the application of these rules on the grounds that they may constitute a restriction on one or more of the EC Treaty freedoms.
IMMEDIATE IMPLICATIONS OF THE CHANGE
The brief announces an immediate change to current HMRC practice by stating that HMRC will no longer seek to apply late-paid interest rules to computations forming part of the corporation tax returns submitted on or after 28 July 2008, or to any other accounting periods ending before the law is amended, in cases where the creditor company is not resident in the UK. HMRC has also confirmed that it will not pursue the application of the current rules in cases where enquiries into returns are currently open on this point.
CONSULTATION DOCUMENT
The government has considered a number of options for changing the current rules to be consistent with the policy objective of ensuring that there is no asymmetry in the tax treatment between debtor and creditor companies, ie circumstances where a debtor company is allowed a tax deduction for interest accrued, but the creditor company is taxable only on receipt. The government has suggested two main options for amending the relevant rules:
1) to apply them in all cases where interest is paid late to a connected creditor company, ie UK-to-UK situations, as well as in cases where the connected creditor company is non-UK resident (option A); or
2) to repeal these and replace them with an anti-avoidance rule (option B).
Under option A, the rules would be extended to include all UK-to-UK loans between connected companies, thereby avoiding the argument that the UK rules are discriminatory against companies resident in other EU member states.
The main concern or objection with this option is that it could theoretically result in double taxation in an intra-group situation. This could arise in circumstances where the debtor company is denied a tax deduction due to its inability to pay the interest expense, while the creditor company's accounts are taxed (outside the UK) on the corresponding interest accruing in the company accounts.
Under option B, paragraph 2(1A) of Schedule 9 to the Finance Act 1996 would be repealed and an antiavoidance rule would be introduced to address the issue of asymmetry between the connected debtor and creditor companies where there is late-paid interest. The anti-avoidance rule would aim to prevent manipulation of connected-party debt where interest payable by the debtor remains untaxed in the hands of the creditor.
HMRC is seeking comments on the abovementioned options and such comments will be taken into account in developing draft legislation for possible inclusion in a future Finance Bill to amend the operation of paragraph 2. Comments should be received by HMRC no later than 24 October 2008.
By Ian Reid, associate, Jones Day.
