21 MARCH 2000 BUDGET-LOANS WITH INTEREST RATES LINKED TO PROFITS

Summary of measures

Companies will be able to claim interest relief on certain loans (‘ratchet loans’) with interest rates linked to profits, it was announced today. This will bring the tax treatment of these loans into line with most other commercial loan arrangements and give companies easier access to the finance they need in order to grow. Transfers of ratchet loans will also be exempt from Stamp Duty and Stamp Duty Reserve Tax.

Further details

1. From Budget Day companies will be able to claim relief for interest on certain commercial loans with interest rates linked to profits (‘ratchet loans’). These are loans where the rate of interest reduces as business results improve (or conversely, the interest rate increases as business results deteriorate). Both new and existing loans will benefit from the change.

2. Previously relief could not generally be claimed for the interest on ratchet loans where the creditor was not a UK company, because the payments were treated as distributions of profit for tax purposes. The change will mean that companies will have easier access to the finance they need in order to grow.

3. The definition of ratchet loans for the purposes of the group relief anti-avoidance rules will be aligned to ensure that these loans are treated as normal commercial loans.

4. Ratchet loans will also be treated as exempt loan capital for Stamp Duty purposes in relation to transfers made on or after Budget Day.

Background notes

Corporation Tax – interest relief

1. Companies are generally able to claim tax relief for interest expenditure. But where the creditor is not within the charge to UK corporation tax, interest on certain loans is treated as a distribution of profit (like a dividend), so that relief is not available. This prevents equity investment being artificially characterised as a loan in order to obtain interest relief.

2. The rules are aimed at loans where there is a right to share in any increase in the profits but currently cover all loans where the interest rate is to any extent dependent on business results. So ratchet loans, where the interest rate reduces as business results improve (or vice versa), currently fall within the scope of these rules even though there is no question of sharing in any increase in the profits. This has made this kind of loan unattractive to borrowers.

Corporation Tax – group relief

3. The group relief rules allow losses and certain other amounts incurred by one company to be set against the profits of another company in the same group. Two companies are members of the same group if one is a 75% subsidiary of the other, or if both are 75% subsidiaries of a third company.

4. There is anti-avoidance legislation to prevent the percentages being manipulated in order to create artificial group relationships, and this legislation includes rules to distinguish between equity capital and normal commercial loans. There is special provision for ratchet loans, so that they qualify as normal commercial loans. But the current definition of ratchet loans is rather narrow and does not include loans where the rate of interest increases as business results deteriorate or as the value of an asset decreases.

Stamp Duty

5. Transfers of most loan capital are exempt from Stamp Duty and Stamp Duty Reserve Tax. But the exemption does not extend to certain categories of loans, including loan capital where the interest is determined to any extent by reference to business results or to the value of any property. So under current rules ratchet loans cannot benefit from this exemption.

Costs

6. The costs of these changes are estimated to be negligible.