UK Finance Bill 2017: Corporate Interest Restriction (“CIR”) legislation/related party provisions

CIR legislation/related party provisions

Mythrayi Manickarajah and Mikko Saressalo provide guidance on whether debt from a 24.9% shareholder is related party debt for the new corporate interest restrictions rules.

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Note to the reader: The measures examined in this article have been removed from Finance Bill 2017. We understand that the Financial Secretariat to the Treasury has notified the House of Commons that these delayed measures are intended to be reintroduced at the earliest opportunity post-election. The expectation is that if the measures are reintroduced, this would occur in a summer Finance Bill soon after the election, and the start dates of these measures are likely to remain at 1 April 2017.

This article considers whether a 24.9% shareholder (“A”) in a company (“B”) meets the requirements to be regarded as a “related party” for the purposes of the CIR rules as included in the CIR provisions of the Finance Bill 2017, which was released on 20 March 2017.

Definition of a “related party”

In Chapter 11, section 463(1) states that for the purposes of the CIR rules, a person (“A”) is a “related party” of another person (“B”)

a) throughout any period for which A and B are consolidated for accounting purposes;

b) on any day on which the “participation” condition is met in relation to them; or

c) on any day on which the 25% investment conditions are met in relation to them.

a) Consolidated for accounting purposes

Section 463(2) states that A and B are consolidated for accounting purposes for a period if their financial results are included, or are required to be included, in group accounts; or they would be included in group accounts if not for the application of an accounting exemption. Group accounts means accounts prepared section 399 Companies Act 2006 (or the corresponding overseas law).

A only holds a 24.9% stake in B and so should not meet this condition.

b) The participation condition

Section 463(4) states that the participation condition is met in relation to A and B (“the relevant parties”) on a day, if within the period of 6 months beginning or ending with that day –

a) one of the relevant parties directly or indirectly participate in the management, control or capital of the other; or 

b) the same person or persons directly or indirectly participate in the management, control or capital of each of the relevant parties.

Section 157(2) of TIOPA 2010 provides that a person (“A”) directly participates in the management, control or capital of another person (“B”) only if that other person is at that time a body corporate or a firm and is controlled by the first person.

A does not control B and so should not meet the first leg of the participation condition.

Section 159(2) of TIOPA 2010 states that a person (“A”) indirectly participates in the management, control or capital of another person (“B”) if A would be directly participating in the management, control or capital of B if certain rights and powers were attributed to A. 

According to section 159(3) of TIOPA, these rights and powers include - 

  • the rights and powers which A is entitled to acquire at a future date;
  • the rights and powers which A will, at a future date, become entitled to acquire;
  • the rights and powers of persons other than A which are required or may be required to be exercised on behalf or A, under the direction of A or for the benefit of A;
  • the rights and powers of any person with whom A is connected; and
  • the rights and powers which would be attributed by section 159(2) to a person with whom A is connected were it being decided under that subsection whether that connected person is indirectly participating in the management, control or capital of B.

Section 163(2) of TIOPA 2010 states that two persons are “connected” with each other if one of them is an individual and the other is the individual’s spouse, relative or relative of the individual’s spouse. Further, two persons are connected with each other if one of them is a trustee of a settlement and the other is the settlor of that settlement or is a person connected to the settlor. Therefore, connection for these purposes does not extend to body corporates.

On the basis that A is not entitled to increase its shareholding in B such that it will control B at a future date or that A cannot direct another person or persons to act at its behest such that it has control of B, A should not meet the second leg of the participation condition.

Section 160(2) of TIOPA 2010 extends the indirect participation in situations where a person (“A”) is indirectly participating in the management, control or capital of another person (“B”) as one of a number of major participants in that other person’s enterprise. For these purposes A is a major participant in another person’s enterprise if at a time that other person is a body corporate or firm and the 40% test is met in the case of each of two persons who taken together control the subordinate, B. The 40% test is met in the case of each of two persons wherever each of them has interests, rights and powers representing 40% of the holdings, rights and powers in respect of which the pair of them fall to be taken as controlling the subordinate.

On the basis that A is not a 40% shareholder (and is not entitled to increase its shareholding in B such that it will control B at a future date or that A cannot direct another person or persons to act at its behest such that it has 40% control of B), A should not meet this extended participation condition.

c) 25% investment condition

Section 464(1) states that a person (“A”) has a 25% investment in a company (“B”) if –

  1. it possesses or is entitled to acquire 25% or more of the voting power in B; 
  2. if the whole of B’s share capital were sold, A would receive 25% or more of the proceeds of the disposal;
  3. on the distribution of dividends by B to equity holders, 25% or more of the amount distributed would be received by A; or
  4. in the event of a winding up of B, 25% or more of its assets available for distribution to equity holders would be received by A.

References to “equity” for the purposes of section 464(1) are to shares in B other than restricted preference shares or loans to C other than normal commercial loans.

On the basis that A is not entitled to acquire additional shares or interests to increase its voting power to 25% and its 24.9% shareholding gives it the right to receive, directly or indirectly, less than 25% of the disposal proceeds if shares in B were sold, distributions made by B or its assets on a winding up, then on first principles this section is not met.

Attribution of rights and interests

Section 465(1) attributes certain rights and interests to A for the purposes of section 464 as follows – 

a) any person connected with A;

b) any person who is a member of a partnership or is connected with a person who is a member of a partnership, of which A is a member; or

c) any person who is a member of a partnership or is connected with a person who is a member of a partnership of which a person connected with A is a member.

Therefore, if A holds its 24.9% interest in B via a partnership, the rights and interests of other members of the partnership may be attributed to A, resulting in A’s shareholding meeting section 464.

Section 1122 CTA 2010 defines “connected” for the purposes of section 465(1) as follows:

A company is connected with another company if – 

Section 1122(2):

a) The same person has control of both companies;

b) A person (“P”) has control of one company and persons connected to P have control of the other company;

c) P has control of one company and P together with persons connected with P have control of the other company; or

d) A group of two or more persons has control of both companies and the groups either consist of the same persons or could be so regarded if (in one or more cases) a member of either group were replaced by a person with whom the member is connected.

Section 1122(3):

A company (“A”) is connected with another person (“P”) if – 

a) P has control of A; or

b) P together with persons connected with P have control of A.

Section 1122(4):

In relation to a company, any two or more persons acting together to secure or exercise control of the company are connected with – 

a) One another; and

b) Any person acting on the directions of any of them to secure or exercise control of the company.

On the basis that all shareholders in B are non-related parties, we would not expect A to meet the connection test set out in section 1122 CTA 2010. 

Section 465(3) states that in determining whether for the purposes of section 464, the investment that a person (“A”) has in another person (“B”), A is to be taken to have all of the rights and interest of a third person (“T”) with whom A acts together in relation to B.

Section 465(4) states that A “acts together” with T in relation to B if (and only if) – 

a) For the purposes of influencing the conduct of B’s affairs, 

  • A is able to secure that T acts in accordance with A’s wishes (or vice versa); or
  • T can reasonably be expected to act or typically acts in accordance with A’s wishes (or vice versa).

b) A and T are party to an arrangement which is designed to affect the value of any of T’s rights or interests in B; or

c) The same person manages some or all of both A’s and T’s rights or interests in B.

Section 465(7) states that for the purposes of section 464, for the investment that A has in B, A is taken to have all of the rights and interests of one or more third persons with whom A has entered into a qualifying arrangement (includes any agreement, understanding, scheme, transaction or series of transactions whether or not legally enforceable) in relation to B. Section 465(8) states that as a result of this “qualifying arrangement”, by reference to shares held or to be held (including rights and interests similar to shares), by any one or more of these third persons in U, they can reasonably be expected to act together –

a) To exert greater influence over B than any one of them would be able to alone; or

b) To achieve an outcome relating to B that would be significantly harder to achieve alone.

Whilst a Shareholders’ Agreement documents agreed protocols for a joint investment (such as B), this does not necessarily mean that T will act as directed by A. Therefore, whether A and T “act together” for the purposes of section 464 this will be depend on the facts at hand.

Section 466(2) states that if A makes a loan to B which is guaranteed by a person related to B (i.e. an investor in B that meets s.463(1)) then A is treated as a related party of B.

Practically speaking, it is unlikely that a minority shareholder such as A would request or be able to demand such a guarantee from co-investors as part of its debt funding in a JV investment vehicle. Therefore, the risk of this provision applying in a scenario such as this appears to be a theoretical one.

Section 467 states that where A lends to B and the amount lent “stands in the same, or substantially the same, proportion as the shares or voting power that A has in B, then A is treated as a related party of B in relation to the loan, provided these lenders (taken together) have a 25% investment in B.

Therefore, unless A’s funding of B is substantially less or more than its 24.9% shareholding in B, then it is likely to be treated as satisfying section 464

Concluding remarks

The CIR rules will have a significant impact on M&A transactions where debt financing features as a key component. The above discussion addresses in detail technical considerations around the drafting of the meaning of “related party” under the CIR rules, that may be particularly relevant in M&A transactions involving co-investors. In the above scenario, in order for A to fall outside of the CIR rules included in the draft Finance Bill 2017 and not be classified as a related party lender to B, any loans made by A to B should not be in proportion to A’s shareholding in B, and A will need to demonstrate that it is not acting together with the other shareholders in B.

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