HMRC have published a paper which discusses and outlines the proposed changes to the corporation tax rules on loan relationships and derivative contracts on amounts not fully recognised for accounting purposes.

HMRC invites views on proposals to amend sections 311 and 312, and sections 599A and 599B, of the Corporation Tax Act 2009 (CTA).

The corporation tax rules on loan relationships and derivative contracts are set out in Parts 5 to 7 CTA. These rules provide that the amounts to be brought into account for tax purposes are those that, in accordance with generally accepted accounting practice (GAAP), are recognised in determining a company's profit or loss for the period.

In certain circumstances where assets and liabilities are ‘matched’, GAAP may permit or require the whole or part of those assets and liabilities (and/or the income arising on them) not to be recognised (or to become ‘derecognised’). Consequently, amounts which would otherwise be brought into account for tax purposes are not brought into account.

Further disclosures to HMRC under the DOTAS rules have indicated that Corporation Tax avoidance schemes involving derecognition continue to be developed. Recently notified schemes have involved derecognition where a company with a loan asset or valuable derivative:

Enters into an agreement with another entity under which in return for additional shares or an increased interest in that entity it undertakes to make payments equal to the amounts it receives (interest and principal) which transfer the benefit of that loan or derivative to the other entity

Derecognises that loan or derivative in an accounting period because it is contractually committed to issue securities to a connected company in the following accounting period that will form part of its capital in that next period

Comments on the draft legislation should be emailed to HMRC by 17 September 2010.

The full text of the paper can be accessed on the HMRC website at http://www.hmrc.gov.uk/drafts/loan–relationships.htm