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Interest-like investment: substantial deviation from commercial rate of interest

This guidance applies to companies that hold shares up to 21 April 2009

The rule provides that an investment is ‘interest-like� where the fair value is likely to increase at a rate which represents a return on an investment of money at a commercial rate of interest, and is unlikely to deviate substantially from that rate of increase. In turn, the definition of commercial rate of interest allows latitude by referring to a rate which is ‘reasonably comparable�.

These two provisions are designed to prevent companies getting round the rules by slightly tweaking a likely rate of increase in the fair value of a share, and should be operated as explained by the following example.

Company A invests in shares in an SPV which are intended to increase in value using outstanding third party obligations. The arrangement is to last a year and it is agreed that the correct comparative deposit rate between the parties would be 5%. The ‘reasonably comparable� test prevents the parties escaping from FA96/S91A by using a slightly different rate such as 5.1% or 4.9%.

It would also be possible for the rate of increase in fair value to be varied during the term of the arrangement but in such a way that that the overall increase over the term was 5%. For instance, it would be possible to build in a rate of 5.5% for the first 6 months and 4.5% for the second 6 months. The ‘unlikely to deviate substantially� rule prevents such manipulation from taking the shares outside S524.

From 12 March 2008, the special tax definition of ‘commercial rate of interest� is repealed. In practice, this will not result in any change in HMRC’s approach to determining whether a rate of interest is ‘commercial�.