Using an authority-owned ‘WasteCo’ special purpose company to hold assets, employ staff and deliver services has a number of benefits. However, the method of funding the WasteCo, and the tax efficiency of such funding, should be a key consideration in structuring any insourcing.
The WasteCo is likely to have working capital requirements and may need to implement capital spending projects in order to provide the services to the required standard. Where the local authority provides loans into the WasteCo, the tax treatment of those loans, and the interest payable, should be considered when assessing whether the services are being funded in a tax-efficient manner.
We outline below a number of issues specifically relating to the WasteCo’s ability to make deductions against corporation tax when it comes to interest payments made on loans.
Anti-avoidance rules that restrict the deductibility of interest payments on loans may apply. These rules may be relevant where a loan is entered into for an unallowable purpose. These include any purpose that is not among the business or other commercial purposes of a company; plus any purpose or activity not within the charge to UK corporation tax; or a main purpose that constitutes tax avoidance.
Re-classification as a distribution
In certain circumstances, interest can be reclassified as a distribution for tax purposes, and this means that a deduction cannot be claimed in respect of the interest payments.
Some examples of circumstances in which these rules may apply are where:
• the interest could be considered as more than a reasonable commercial return for the use of the principal.
• the interest arises in respect of securities that are issued otherwise than for new consideration.
• interest is treated as being results-dependent, i.e. it depends to an extent on the results of the company’s business. HMRC may treat interest that is on limited recourse terms, or which may be extinguished in certain situations, as results-dependent for these purposes.
• the interest is in respect of securities that are treated as ‘connected with shares’ in the company.
The rules in the second, third and fourth points above do not apply in respect of interest paid to a UK corporation taxpayer except to the extent that the interest is within the first point above.
The transfer pricing rules require connected parties that buy and sell goods and services between themselves to charge the same prices that they would if the transaction occurred at arm’s length. The rules are relevant where a provision is made in relation to a transaction between two enterprises under common control or management. For example, where one enterprise directly or indirectly controls the other.
The rules also apply to interest payments. Any tax deduction for interest may be restricted by reference to an arm’s length provision that would have been made between two independent enterprises.
The rules may apply if the amount borrowed is greater than the amount that could have been borrowed if the lender was an independent third party, or if the interest rate charged on the loan exceeds an arm’s length rate.
Generally the transfer pricing rules will not apply to a small or medium-sized enterprise unless one of the parties to the transaction is a resident of a “non-qualifying” territory, or where HMRC has issued a notice requiring a medium-sized enterprise to apply the rules.
The rules may apply regardless of whether the lender is a UK or non-UK resident company.
Trading or non-trading deductions
The purpose for which a loan is taken out will affect whether a deduction is considered to be a trading or non-trading deduction. This distinction may be relevant as non-trading loan relationship debits can only be carried forward to be set off against non-trading profits in future tax periods.
This may change from April 2017 as the government has proposed changes that would allow companies to carry forward losses to set off against different income streams. However, there are also proposals that could come into effect at the same time, which would limit the amount of taxable profit that can be off-set against carry forward of losses to 50% of profits over £5 million.
With increasing pressure on budgets and service delivery, considering the tax treatment of WasteCo funding arrangements should be part of any service review as tax efficiencies may produce savings that can, in turn, be used to improve frontline service provision.
About the authors:
Nigel Popplewell is a partner in Burges Salmon’s corporate tax team and Sam Sandilands is a senior associate in the firm’s energy team