HMRC has now issued the draft legislation to be included in Finance Bill 2014 relating to bond funds i.e. collective investments that are more than 60% invested in loan relationships.
The legislation and related guidance can be found here:
From a quick (ish) read through I would say the legislation does the following.
Firstly it changes the wording of CTA 2009 section 490. (Which is the basic rule that funds with over 60% of their investments in loan relationships are treated as loan relationships.) Particularly significant is the introduction of 490 2(b) which covers distributions from bond funds received by companies and operates so that:
"b) any distribution in respect of
the relevant holding were not a distribution (and accordingly is within Part 5)"
So this seems to be saying that all distributions received by a company from a relevant holding (i.e. bond fund) are taxable as loan relationship income.
What I don't follow here is what this means if an AIF bond fund pays a distribution that is not an interest distribution? Does the FII part of the streamed distribution become taxable under the loan relationship legislation? If this were to be the case I think it would give an incorrect result. That is if a UK AIF had 61% of its assets in gilts and 39% in equities it may either choose not to pay an interest distribution or might not be able to (say its equity holding had gone over 40% during the distribution period). It would then seem correct that 39% or so of the dividend should be franked and not taxable. Does the proposed legislation turn franked payments into taxable loan relationships, leading to double taxation?
The comment in the guidance is that
"Any distributions or other sums arising from the holding to the company are to be included in the fair value calculation and are not to be treated as distributions for tax purposes
(section 490(2)(b)).
The sums to be taken into account include any interest distributions and the gross amount of the unfranked part of dividend distributions from authorised investment funds (i.e. including any income tax treated as having been deducted), along with all other types of distribution or dividend from funds other than authorised investment funds."
Which I think could be read as saying that the FII element of a streamed distribution is not taxable as loan relationship income. But the guidance is not as clear as I would like and I'm not sure it is what the legislation says.
The revised changes to the legislation also makes some alterations to CTA 2009 section 465. These are interesting changes and I wonder if they reveal a flaw in the legislation as it stands. I'll have a think about this and may post again.
Unfortunately HMRC have gone ahead and introduced new anti avoidance legislation for the bond fund provisions of section 490. As a result the old section CTA 2009 492 that had two subsections has been completely overhauled and now runs to 5 subsections. The overall intention seems to be to extend the anti avoidance legislation so that it applies to not only bond funds but where:
" a related fund enters into any arrangements,or arrangements are entered into that in whole or part relate to a related fund,"
So we now have all sorts of terms that are defined very widely in the legislation: related fund, arrangements and tax advantage. During the initial consultation there had been representations that the anti avoidance legislation should only apply where funds did not meet the diversity of ownership condition in si 2006/964. The guidance makes some encouraging noises that, generally, the new 492 will only apply where there isn't diversity of ownership but leaves HMRC wriggle room to apply it in other circumstances as well.
I don't feel the anti avoidance legislation is a disaster but its wide ranging nature combined with the rather sparse guidance might lead to future problems. Hopefully in the next (brief) consultation process HMRC can be persuaded to either narrow down the potential impact of the legislation or expand the guidance. An example of the type of tax avoidance the new 492 is intended to prevent, and how the legislation would be used to counteract this avoidance would be useful.
There are also amendments to the qualifying investments test in CTA 2009 463. The changes apply where a bond fund invests in another collective that is also a bond fund and deals with an apparent defect in the existing wording.
The new legislation comes into effect from 1 April 2014 but there is an unwelcome proposal that " an accounting period beginning before, and ending on or after, 1 April 2014 is to be treated as if so much of the period as falls before that date, and so much of the period as falls on or after that date "
Responses to the draft legislation and guidance are to be submitted by 14th February.
Responses to the draft legislation and guidance are to be submitted by 14th February.
The guidance ends with the following comment:
"Separately, HMRC will consult further on proposals to permit companies to make a claim
that section 490 CTA 2009 should not apply in certain prescribed circumstances; and to
remove non-exempt unauthorised unit trusts from the scope of the bond fund rules. Any
changes will be made in secondary legislation under existing powers in sections 17(3)."
So there may be more to come on this.
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