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Disallowance of interest

Where HMRC has identified interest as non-arm’s length because the borrower is thinly capitalised, Part 4 of TIOPA10 simply disallows the non-arm’s length element in the borrower’s tax computation.

»Ê¹ÚÌåÓýapp disallowed interest remains interest for tax purposes, which means that unless the interest paid falls into an exempt category, for example it is payable on a qualifying Eurobond - (see ), the provisions of ITA07/S874 apply:

1 - This section applies if a payment of yearly interest arising in the United Kingdom is made�

(a) by a company,

(b) by a local authority,

(c) by or on behalf of a partnership of which a company is a member, or

(d) by any person to another person whose usual place of abode is outside the United Kingdom.

2 - »Ê¹ÚÌåÓýapp person by or through whom the payment is made must, on making the payment, deduct from it a sum representing income tax on it at the savings rate in force for the tax year in which it is made.

»Ê¹ÚÌåÓýapp disallowed amount will have lost any treaty clearance it may have had, and the withholding obligation is reasserted.

This contrasts with pre-2004 treatment, where “excessive� interest which was disallowed under the thin cap legislation at ICTA88/S209 was reclassified for tax purposes as a distribution and tax treatment would be consistent with that recharacterisation.

However, as an extension of the compensating adjustment legislation, TIOPA10/S187 may apply to remove the non-arm’s length interest from the charge to income tax. See INTM413150.