IR35 29 November 1994 NEW ANTI-AVOIDANCE RULES : FINANCIAL ASSETS HELD BY ASSOCIATES OF BANKS The Chancellor proposes in his Budget to take action against the use of special-purpose subsidiaries by banks to defer, or possibly eliminate, tax liability on the returns to certain financial assets which would be immediately taxable if the assets were held directly by the parent bank. These assets will for the future be treated for tax purposes as being sold and reacquired each year, so bringing the successive accruals of financial return into charge to tax. The Chancellor's intention is to prevent a loss of tax estimated at some Pounds 100 million a year; and pre-empt further loss of tax in future. These measures will have effect from today. Draft legislation will be available shortly. DETAILS 1. The proposals will apply to all debt securities held by associates of banks, unless they are excluded by the tests described below. These tests are designed to focus the new charge on holdings of securities offering a deferred return. 2. The charge proposed will be modelled on that already imposed on certain multinational enterprises by Sections 63 to 66, Finance Act 1993. Securities (and other debts on comparable terms) will be treated as disposed of and re- acquired each year - if they are held by an associated company of a company (UK-resident or otherwise) which carries on a banking business in the United Kingdom; - unless the security (or other debt) pays interest at least yearly at a fixed rate or a rate linked to a market interest or a price index and is not on "deep discount" or "deep gain" terms as defined in Schedule 4 to the Taxes Act 1988 and in Schedule 11 to the Finance Act 1989; or - unless they are assets held for the purposes of long term insurance business. 3. Returns already accrued when the legislation comes into effect will not be chargeable immediately but only when the assets in question are disposed of or redeemed. Uplift on indexed securities (or other debt) will be chargeable notwithstanding in the case of securities that they may satisfy the tests for "qualifying indexed securities" in Schedule 11 to the Finance Act 1989: but uplift already accrued when the legislation comes into effect will be disregarded. 4. Draft legislation will be available from 5 December. Copies may be obtained post-free from Mrs L A Latham, Inland Revenue, Financial Institutions Division, 5th Floor, 22 Kingsway, London WC2B 6NR. NOTES FOR EDITORS 1. Securities issued on terms which generate, or may generate, profits on redemption or disposal, in substitution in whole or part for interest on the security, are taxable under the existing "deep discount" and "deep gain" legislation. But tax is not in general due until the securities are redeemed or sold. Tax may be similarly deferred if the timing of interest payments is deferred or the amount of interest paid is, for example, loaded preferentially into the last years of a security's existence: tax is again only due when the interest is actually paid or the securities are sold. 2. These rules are however overridden where securities with these characteristics are held directly by banks. The returns from holding them are not taxed as discrete items of income; instead they count as a contribution to the overall trading profit of the banking business which is taxable under Case I of Schedule D. These profits are calculated, consistently with the accounting standards applicable to banks, on the basis that financial returns are recognised currently, as they accrue. 3. These rules apply only to the company within a banking group which carries on a banking business and to any other member of the group which falls to be taxed as a financial trader. Financial assets acquired by a group member set up merely to hold assets are not chargeable under Case I of Schedule D and attract the deferred basis of charge applicable to investors generally. This is so even though the group member may - and generally will - be funded by lending from the parent bank and so acts in effect as a conduit for lending by the parent bank. 4. The regular deemed disposal and re-acquisition proposed by this measure brings forward the tax charge, to the extent it has so far accrued, which would otherwise be deferred, and so aims to produce broadly neutral results compared to the case where a bank holds assets directly as part of its banking trade.