Revenue Note for Guidance

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Revenue Note for Guidance

249 Rules relating to recovery of capital and replacement loans

Summary

This section is intended to prevent abuse of the provisions contained in sections 247 and 248. Abuse could take place by the recovery of capital from the company in which borrowings were invested or from a company connected with it. Also a company could recover capital from the company in which it intends to invest before it borrows the funds in respect of which tax relief is given for the investment.

If the borrower recovers an amount of capital from the company or a connected company without utilising it to reduce the money borrowed for the purpose of acquiring the interest in the company, the section provides that the borrower will thereafter lose relief on the interest referable to the amount of the borrowed money corresponding to the capital recovered.

If the borrower (being a company) makes an investment in a company which is itself a holding company and this company makes a recovery of capital from one of its directly held subsidiaries without either —

  • passing the funds recovered back to the investing company in order to pay off the loan attracting tax relief, or
  • using the funds recovered for certain approved purposes,

then, there will be a deemed recovery of capital by the borrower and the rules relating to a recovery of capital will apply.

A recovery of capital will, subject to certain exceptions, also be deemed to occur where the borrower makes an investment in a holding company that holds shares in a trading company or companies indirectly through one or more intermediate holding company or companies, and an intermediate holding company recovers capital from another company. The deemed recovery provision does not apply in similar circumstances to those noted above as well as where——

  • the capital recovered is used by the intermediate holding company to repay a loan made to it by the company concerned, or
  • for bona fide commercial reasons, such as to facilitate a streamlining of the group structure, an intermediate holding company transfers its assets and liabilities to another intermediate holding company.

The section also extends the concept of “recovery of capital” to a recovery effected from the company to be invested in within a 2 year period before the borrowed funds are actually invested except where the funds recovered are used for certain purposes. The purposes concerned are either the repayment of another loan which itself qualifies for relief or the capital recovered is applied to acquire shares in, or in lending to, a trading company, a property rental company or a holding company of such a company.

As respects a deemed recovery of capital and a recovery of capital before the investment of the borrowed funds, the section provides that certain payments made by the company to be invested in to the investing company or, in the case of a deemed recovery of capital, by the subsidiary company to the company invested in by the borrowing company, will not constitute a recovery of capital or a deemed recovery of capital. Such payments, therefore, will not trigger a restriction of relief. The payments concerned are the repayment of loans used for trading or property rental purposes and the repayment of loans made before 6 February 2002.

The section also provides that where relief is claimed for interest on a loan which replaces another loan, any restriction on relief in respect of interest on the original loan is to apply to interest on the loan which replaces it.

Details

Definitions

(1)(a)(i) The definition of “relevant period” sets out the period before the application of the borrowed funds within which a recovery of capital by the investing company from the company invested in will result in a restriction of relief. The period concerned is the two year period immediately before the date of the application of the loan.

The second definition defines certain categories of loans the repayment of which will not trigger a recovery of capital in advance of the application of the proceeds of the loan or a deemed recovery of capital and consequently a restriction of relief. The loans concerned (referred to as “specified loans”) are —

  • any loan taken out before 6 February 2003,
  • loans used for ordinary trading purposes, and
  • loans used for the purposes of a rental business.

Recovery of capital before application of loan

(1)(a)(ii) Where the borrower (being a company) makes a recovery of capital in a two year period before any borrowed funds are actually applied (the relevant period) from the company in which it invests in, then a restriction of the relief which would otherwise be available in respect of any interest paid on the borrowed funds results. The circumstances in which a recovery of capital is treated as happening in the relevant period are the same as apply where the borrower makes a recovery of capital after the application of the borrowed funds.

Provision is made to ensure that the restriction on the relief does not arise where the recovery of capital is —

  • represented by the repayment of a “specified loan” (in other words any loan taken out before 6 February 2003 or an ordinary trading loan or loan for the purposes of a rental business) by the company to be invested in to the borrower,
  • used to repay some other loan which qualifies for tax relief under section 247 for interest paid (this recognises that there should not be a restriction of future relief where capital recovered is used to repay an outstanding loan which qualifies for tax relief), or
  • used by the borrower to acquire shares in, or lending to, a trading company, a property rental company, or a holding company of such a company (this recognises that in certain circumstances a company may not be able for contractual reasons to pay off its borrowing but may be able to use the funds recovered for re-investment purposes).

Provision is also made to ensure that a recovery of capital does not operate to restrict all relief to be made within the two year look-back period. In other words, a recovery of capital will cause the restriction of relief in respect of one loan only.

Recovery of capital by borrower

(1)(a)(iii) & (iv) Where the borrower (being either an individual or a company) recovers an amount of capital from the company concerned or from a connected company, or in the case of a borrower that is a company, is deemed to recover an amount of capital from the company concerned, without using it in reducing the loan to which section 247 or 248 applies, the borrower is treated as having repaid the loan to the extent of that amount and thereafter the borrower loses relief in respect of the interest or a part of it as appropriate.

(2)(a) The borrower is treated as recovering an amount of capital from a company if —

  • the borrower sells ordinary shares in the company or in a connected company for money or money’s worth or receives money or money’s worth as a repayment of ordinary share capital of the company or of a connected company,
  • the company or a connected company repays the amount of a loan or advance from the borrower, or
  • the borrower assigns a debt due to the borrower from the company or from a connected company for money or money’s worth.

(2)(b) If the borrower gives away the shareholding for less than arm’s length value, the borrower will be deemed to have recovered from the company the market value of the shares.

Deemed recovery of capital by a borrower (being a company)

(2)(aa)(i) This provision only applies where the company concerned (that is, the company invested in) is a holding company (this is the meaning of the reference to section 247(2)(a)(iii), (iv) or (v)). Where the company concerned is a holding company, the borrower is deemed to have made a recovery of capital where the company concerned has itself recovered capital from one of its subsidiaries (for this purpose a company is considered a subsidiary of the company concerned where the company concerned owns directly more than 50 per cent of the ordinary share capital of the other company) without using the capital recovered to —

  • repay a loan made to it by the borrower (this in turn triggers a recovery of capital by the borrower thereby requiring it to use the capital recovered in repaying the loan for which it is getting tax relief for interest or else suffering a restriction of the relief in an amount equal to the amount recovered),
  • redeeming any of its ordinary share capital acquired by the borrower (again this triggers a recovery of capital by the borrower with the consequences set out above),
  • acquire shares in, or lending to, a trading company, a property rental company, or a direct holding company of such a company or, in certain circumstances, of a holding company that holds shares in a trading company indirectly through one or more intermediate holding companies (this recognises that in certain circumstances a company may not be able to repay a loan or redeem its shares and allows a company to avoid a recovery of capital where it re-invests the funds recovered), or
  • repay some other loan which qualifies for tax relief in respect of interest paid under section 247 (this recognises that there should not be a restriction of relief where capital recovered is used to repay other borrowed funds which qualified for tax relief).

(2)(aa) The circumstances in which the company in which the borrower has invested is treated as having made a recovery of capital from one of its subsidiaries are the same as apply to a recovery of capital by the borrower itself, except that the repayment of —

  • a loan which was taken out before 6 February 2003,
  • a loan for trading purposes by the subsidiary, or
  • a loan used for the purposes of a rental business carried on by the subsidiary,

is not treated as a recovery of capital by the company concerned and therefore cannot be treated as a deemed recovery of capital by the borrower.

(2)(aa)(iii) Provision is made for the apportionment of any capital recovered by the company concerned where more than one company qualifies as an investing company in relation to the company concerned. In other words, where two or more companies have borrowed to invest in the company concerned and all the investing companies qualify for tax relief for the interest paid in respect of the borrowings. In such circumstances any recovery of capital by the company invested in (that is, the company concerned) would trigger a deemed recovery of capital by each of the investing companies and without this provision would restrict all loans equally.

Share for share reorganisations

(2)(ab) In respect of loans made on or after 21 January 2011, companies may elect that the recovery of capital provisions of this section will not apply in the case of a reorganisation involving an exchange of shares that section 584 applies to or which but for section 626B, would apply by virtue of section 586. Where such an election is made, the new shares will be treated as if they were the old shares for the purposes of applying this section on a subsequent disposal of those new shares.

Deemed recovery of capital where an intermediate holding company recovers capital

(2)(ac) This provision applies where the company concerned (that is, the company invested in) is a holding company that indirectly holds shares in a trading company through one or more intermediate holding companies (this is the meaning of the reference to section 247(2)(a)(iv))). Where the company concerned is such a holding company, the borrower is deemed to have made a recovery of capital from the company concerned where, in certain circumstances, an intermediate holding company recovers capital from another company. In order for this deemed recovery of capital provision to apply, certain ownership requirements must be met in relation to both the intermediate holding company and the other company. In particular, for the provision to apply:

  • the company concerned must own at least 50% of the ordinary share capital of the intermediate holding company, whether directly or indirectly, or both companies must be under the control of the same person or persons; and
  • the intermediate holding company must directly own more than 50% of the ordinary share capital of the other company or both companies must be under the control of the same person or persons.

(2)(ac)(ii) The circumstances in which an intermediate holding company is treated as having made a recovery of capital from another company are the same as apply to a recovery of capital by the company concerned as set out in paragraph (aa)(ii).

(2)(ac)(iii) An investing company will not, in certain circumstances, be deemed to have made a recovery of capital under subparagraph (i). These circumstances are where——

  • the capital recovered by the intermediate holding company is used to repay a loan made to it by the company concerned,
  • the capital recovered by the intermediate company is used for the purposes set out in paragraphs (a) or (b) of subsection 247(2),
  • the capital recovered by the intermediate company is used to repay a loan to which section 247 applies, or
  • the recovery of capital arises in the event of an intermediate holding company (other than an intermediate holding company referred to subparagraphs (i) or (ii) of section 247(2)(bb)) being dissolved without going into liquidation and its assets and liabilities are transferred to another intermediate holding company. The dissolution and transfer of assets and liabilities must be for bona fide commercial reasons and not for the purposes of tax avoidance and the company concerned must continue to hold indirectly the same beneficial percentage of shares in the trading company that it held prior to the dissolution.

Share for share reorganisations

(2)(ac)(iv) The provisions of subparagraph (ab) are modified so as to apply in the context of an intermediate holding company. Companies may elect that the recovery of capital provisions of this section will not apply in the case of a reorganisation involving an exchange of shares that section 584 applies to or which but for section 626B, would apply by virtue of section 586. Where such an election is made, the new shares will be treated as if they were the old shares for the purposes of applying this section on a subsequent disposal of those new shares.

Multiple Recovery of Capital

(2)(ac)(v) Provision is made to prevent more than one deemed recovery of capital under this paragraph or under paragraph (aa) arising from related transactions or sequence of events. A company may by notice is writing exclude an amount of capital deemed to have been recovered under this paragraph (referred to as capital previously recovered) from a subsequent recovery of capital under this paragraph or under paragraph (aa) where the capital previously recovered arose within a reasonable period of time and by reference to a related transaction or event. The investing company must maintain and make available such records as are required to reasonably show that the relevant requirements are satisfied.

Apportionment of Capital Recovered

(2)(ac)(vi) The rules relating to the apportionment of a recovery capital by the company concerned where more than one company qualifies as an investing company in relation to the company concerned are applied and modified in the context of a deemed recovery of capital under paragraph (ac). Where two or more companies have borrowed to invest in the company concerned and all the investing companies qualify for tax relief for the interest paid in respect of the borrowings. In such circumstances any recovery of capital by the company invested in (that is, the company concerned) would trigger a deemed recovery of capital by each of the investing companies and without this provision would restrict all loans equally.

Arm’’s Length requirement

(2)(b) If the borrower gives away the shareholding for less than arm’s length value, the borrower will be deemed to have recovered from the company the market value of the shares.

Substitute loans

(3) Where relief is claimed for interest on a substituted loan, the same conditions apply as if all the loans were one loan.

Relevant Date: Finance Act 2017