Interest double dip – Effect of anti-avoidance provisions
US Co. acquired UK Group in 2004, and a structure was put in place which allowed tax relief to be claimed in both the US and the UK in respect of interest on the financing costs. Advice was sought on whether the structure was later caught by provisions introduced in the Finance (No. 2) Act 2005 to prevent avoidance involving tax arbitrage. The provisions (sections 24 to 31 of and Part 2 of Schedule 3 to Finance (No. 2) Act 2005) were aimed at structures based on the use of hybrid entities, where the main purpose, or one of the main purposes, of setting up such a structure was to achieve a UK tax advantage.
As US Co. had used a hybrid entity, the financing arrangements constituted a ‘qualifying scheme’ for the purposes of the legislation. The structure put UK Group in a position to claim a deduction for corporation tax purposes (by way of group relief surrendered by the hybrid entity), and such deduction was more than a minimal amount. The anti-avoidance legislation therefore applied to the financing arrangements unless it could be shown that it was not the main purpose, or one of the main purposes, of such arrangements to achieve a UK tax advantage.
It appeared that the main reason for using a hybrid entity was to obtain tax relief in both the US and the UK in respect of the same interest payments and therefore to achieve a UK tax advantage. US Co. could have purchased the share capital of UK Group directly and borrowed the money to do it, giving rise to a US tax deduction only. On this basis the anti-avoidance legislation applied.
The structure was unwound.
At the time of publication this case study was technically accurate however, as tax law and practice change rapidly, you should take specific advice before taking any action.