The HM Treasury document "Investment trust companies: next steps" can be found at

http://www.hmtreasury.gov.uk/consultinvestmenttrust_companies.htm.

The Government has published a summary of responses to its consultation paper of 28 July 2008 and draft regulations on the optional treatment of dividends as interest distributions.

Consultation paper

The consultation paper set out proposals to enable Investment Trust Companies (ITCs) to invest in bonds tax efficiently by 'streaming' their income from interest bearing assets (see further our e-bulletin of 1 August 2008)

Further proposals

ITCs which meet certain criteria set out in section 842 of the Income and Corporation Taxes Act 1988 are currently exempt from corporation tax on chargeable gains but pay corporation tax on income (except UK dividends). The proposals outlined in the consultation paper are for the interest income to remain taxable in the ITC but the distribution will be deductible from corporation tax when paid to shareholders as an 'interest distribution'. The interest distribution will be treated as a payment of yearly interest and income tax at the lower rate will be deducted and accounted for by the ITC, unless the shareholder is entitled to receive interest gross.

Herbert Smith LLP and other interested parties responded to the consultation paper and some of their concerns have been addressed by the Government. In brief:

  • the Government believes that an ITC should inform HMRC that it has or wishes to stream interest when it applies for approval as an ITC for the relevant accounting period;
  • the Government does not consider it necessary for ITCs to distribute interest income in priority to other income;
  • the Government has rejected suggestions that undistributed interest income should be carried forward and paid to investors in subsequent periods as an interest distribution because it believes that this would give investors in ITCs a tax advantage over those who invest directly in interest bearing assets;  
  • in response to queries as to how "interest bearing assets" will be defined, a definition has been included in the draft regulations;  
  • the Government recognises that there will be both one-off costs in opting into the new regime (eg, adapting systems to the 'streaming' rules, disclosure to shareholders) and on-going operational costs in making gross and net payments, but believes that the optional nature of the regime means that ITCs will only opt-in if the benefits outweigh the costs;  
  • the Government has confirmed that a company will be able to make an interest distribution before it gains approval as an ITC for an accounting period provided that it intends to seek approval for that accounting period and has a reasonable belief that approval will be granted. Guidance will be published on how a company will be able to demonstrate "reasonable belief". However, if a company deducts interim interest distributions from its liability to corporation tax but fails to gain approval as an ITC for the accounting period and either did not intend to seek approval or did not have a reasonable belief that approval would be granted, the interest deduction will not be tax deductible in the company. However, in order to ensure certainty of tax treatment for shareholders, the distribution will not be reclassified as a dividend in the shareholders' hands.  

The draft regulations (subject to amendment following further consultation) are intended to be included in Finance Bill 2009 and to come into force for accounting periods beginning on a date to be appointed as soon as possible after Royal Assent. The Government does not intend any transitional provisions to apply.

Comments on the draft regulations should be sent by 11 February 2009 to Sue Harper at sue.harper@hm-treasury.gov.uk.