New Corporate Tax Rules On Late Interest Payments Proposed In UK

by Robert Lee, Tax-News.com, London

30 July 2008

The UK tax authority, HM Revenue and Customs, has issued a consultation on proposed changes to the laws relating to the deduction of interest on late payments between connected companies in the light of recent judgments by the European Court of Justice (ECJ).

The tax treatment of connected party debts is dealt with by the 1996 Finance Act, referred to as 'paragraph 2' rules which deny the debtor company a tax deduction for interest paid late.

Paragraph 2 applies where interest payable by a debtor company to a connected creditor is not paid within 12 months of the end of the accounting period in which it accrues, and is not brought into account by the creditor under the loan relationships rules. In such a case, the debtor company is allowed a deduction for the interest when it is paid. Thus, where a UK company is liable to interest on a loan from an overseas company in the same group, and the UK company does not pay the interest within 12 months of the accounting date, the interest is only deductible on a ‘paid’ basis.

However, recent decisions of the ECJ have raised the question of whether paragraph 2 as it stands is compatible with the principles of European Community law which guarantee non-discrimination.

As a consequence of this, HMRC has now set out two main options for change, which will involve amending paragraph 2.

The first would apply the rule in paragraph 2 in all cases where interest is paid late to a connected creditor company in UK-to-UK situations, as well as in cases where the connected creditor company is non-UK resident. HMRC believes that such an approach would allow a modest simplification of the loan relationships regime, since the same rule would apply in all connected company situations, whether the creditor company is resident or non-resident in the UK. HMRC also believes the change would be easily understood and would not make any significant difference to the cost of compliance with the loan relationships rules.

However, HMRC concedes that this change could result in double taxation in an intra-group situation; that is, denial of a tax deduction in the debtor company, while the creditor is taxed on the corresponding interest on accrual in the company accounts.

The second proposal is to repeal paragraph 2(1A) and replace it with an anti-avoidance rule. According to HMRC, under this scenario, the majority of companies would no longer need to consider the need for an automatic adjustment in their tax computations in cases where the debtor and creditor company are connected. However, all companies would need to consider the application of anti-avoidance rules within the loan relationships regime.

HMRC is accepting comments on its proposals until 24th October, 2008.

Recommended