Finance Bill 2002: EXPLANATORY NOTE
CLAUSE 68: QUALIFYING CONTRACTS FOR UNALLOWABLE PURPOSES
SUMMARY
1. This clause inserts an ?unallowable purposes? rule into Chapter 2 Part 4 Finance Act 1994 (financial instruments) as section 168A FA 1994. The new clause follows closely the terms of paragraph 13 Schedule 9 FA 1996 (loan relationships), but adapting the provisions of that paragraph to follow the different terms and methods of operation of the financial instrument rules.
2. This is an anti-avoidance rule which will take effect from 26 July 2001, the date it was announced. The rule is replaced with effect for periods beginning on or after 1 October 2002 by a similar rule in the derivative contracts rules in Schedule 26.
DETAILS OF THE CLAUSE
3. Subsection 1 inserts a new section 168A into Finance Act 1994.
New section 168A(1) provides that, if a company is party to a qualifying contract for an unallowable purpose, then so much of any payments it makes under the contract as are, on a just and reasonable apportionment, attributable to that purpose, are not treated as part of amount B in making the computation required by section 155 FA 1994, and so cannot be deducted in arriving at the company's trading profits and cannot reduce its loan relationships non-trading profits charged under Case III, nor increase any non-trading deficit.
New section 168A(2) and (3) limits the amount that may be disregarded. It cannot exceed the amount by which the whole of the amount B (the payments made by the company under the contract) exceeds the amount A (the receipts). Thus if amount A is 800, amount B as a whole is 1000, and the part of amount B that would fall to be disregarded is 500, only 200 (1000 - 800) may actually be disregarded. If amount A was 1000 and amount B 800, no part of amount B would fall to be disregarded.
New section 168A(4) makes it clear that amounts A and amounts B are found in the first instance for this test without regard to any amount of part B that falls to be disregarded by virtue of section 168A(1).
New section 168A(5) defines an ?unallowable purpose? as one which is not among the business or other commercial purposes of the company.
New section 168A(6) and (7) specify two cases where there is no business or other commercial purpose. One is where the company has activities not within the charge to corporation tax (for example where a non-resident company trades through a branch in the UK but has other activities outside the UK tax net). The other is where it is party to a contract for a tax avoidance purpose, and that purpose is the main or one of the main purposes for which the company is party to the contract.
New section 168A(8) and (9) define a ?tax avoidance purpose? in terms identical to those in paragraph 13 Schedule 9 FA 1996.
4. Subsection (2) gives the commencement: accounting periods ending on or after 26 July 2001, so long as the company is still a party to the contract at that date.
5. Subsection (3) provides that where a company was party to a contract to which the section applies on 26 July 2001, an apportionment is made between the parts of the affected amount B falling before 26 July and the parts falling on or after, on a just and reasonable basis.
6. Subsection (4) also provides that in those same circumstances, for the purposes of the limitation in section 168A(2) and (3), amounts A and amounts B are also apportioned on a just and reasonable basis.
BACKGROUND
7. This section is an anti-avoidance provision - intended to be a general provision aimed at preventing companies exploiting the financial instruments rules. It is closely modelled on the ?unallowable purposes? rule in the loan relationships legislation which has been in effect since 1996.
8. It denies tax relief to the extent that payments exceed receipts on a qualifying contract (a contract within the financial instruments rules in FA 1994) where a company has entered into, or is a party to, the contract but not for business or commercial purposes.
9. A purpose which is wholly or mainly for reducing corporation tax liability does not count as a commercial or business purpose - similarly, nor does a purpose which is related to activities outside the corporation tax net.
10. The clause makes clear that, for a tax reduction purpose to result in any disallowance, it must be a main purpose or one of the main purposes of the transaction - furthermore, any disallowance in respect of an ?unallowable purpose? is only to be on a just and reasonable basis. For instance, even the fact that there is a main purpose which is a tax reduction does not mean that everything gets disallowed - only a ?just and reasonable? amount.
11. The clause was announced in a Consultative Document (?Corporate Debt, Financial Instruments and Foreign Exchange Gains and Losses?) published on 26 July 2001.
12. It takes effect for accounting periods ending on or after 26 July 2001. Where a qualifying contract to which the new rule applies was held prior to the 26 July, the clause only applies to restrict amounts attributable to the period following 25 July. A ?just and reasonable? apportionment is to be made to attribute amounts between the two periods.