Revenue and Customs Brief 26/07
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Issued 21 March 2007
Alternative finance arrangements – “diminishing shared ownership” cases –
implications for capital allowances and capital gains
- HM Revenue and Customs has been asked about the implications for capital
allowances and for capital gains of certain types of alternative finance
arrangements commonly referred to as diminishing shared ownership, or
diminishing musharaka, arrangements. This brief gives general guidance on
- plant and machinery allowances within Part 2 of the Capital Allowances Act
2001 (CAA 2001)
- taper relief – for capital gains tax purposes.
- indexation allowance – for corporation tax purposes.
- In 2005 and 2006 the Government introduced new income and capital gains
tax rules for certain alternative finance arrangements under which it is
possible to borrow from or invest with financial institutions on terms which
do not include payment or receipt of interest. The legislation is contained in
chapter 5 (sections 46 to 57) of the Finance Act 2005 (FA 2005).
- Where these rules apply, the broad effect is:
- Receipts which are economically equivalent to interest are liable to tax
in the same way as interest.
- These amounts are also treated in the same way as interest from the
payer’s perspective; where appropriate, that includes a requirement to deduct
tax from the amount paid.
- Where the arrangements involve the sale and purchase of an asset, amounts
treated in the same way as interest are normally excluded from the
consideration for the sale and purchase of the asset in question for both
capital allowances purposes and capital gains purposes (section 53 FA 2005).
What are diminishing shared ownership [‘DSO’] arrangements?
- There is no set format for DSO arrangements. It is therefore necessary to
examine the terms of individual arrangements to determine their effects. But
where a person (the “buyer”) enters into DSO arrangements to acquire an asset
(such as residential property or business premises), the main features of the
arrangements are broadly as follows:
- The owner of the asset contracts to sell it, with the buyer and a
financial institution agreeing to contribute a set proportion of the sale
price. The financial institution acquires legal title to the asset. The
buyer’s initial interest in the asset is restricted to his or her contribution
to the sale price. For example, if the buyer contributes 10% and the financial
institution 90%, the buyer will have a 10% interest in the asset to begin
- The buyer and the financial institution enter into a further agreement
under which the buyer makes successive payments to the financial institution
to acquire further proportionate interests in the asset. When all agreed
payments have been made and the buyer has acquired the whole of the financial
institution’s beneficial interest, the financial institution can be obliged to
transfer legal title to the buyer.
- The financial institution also agrees to lease the asset to the buyer for
the period in which it continues to have a beneficial interest in the asset.
The buyer makes rental payments to the financial institution under this
- Section 47A FA 2005 provides that for both parties amounts other than
consideration paid for the acquisition of the financial institution’s
beneficial interest and payments in respect certain arrangement fees, legal or
other costs are “alternative financial returns”.
What are the implications of DSO arrangements for capital allowances for
plant or machinery?
- The general rule is that to qualify for plant and machinery allowances a
- must be carrying on a Qualifying Activity (includes all trades
professions, vocations and almost all property businesses); and
- incur qualifying expenditure (broadly qualifying expenditure is capital
expenditure on the provision of plant or machinery wholly or partly for the
purposes of the qualifying activity and as a result of incurring that
expenditure owns the plant or machinery.
This general rule does not give an entitlement to plant and machinery
allowances to the buyer as legal title remains with the financial institution
until all the agreed payments have been made.
- These general rules do not apply to contracts under which the lessee shall
or may become the owners (for example, hire purchase contracts). In this
situation special rules in section.67 CAA 2001 treat the person making the
payments under the contract (the lessee) as the owner of the asset as soon as
that person is entitled to the benefit of the contract. It also stops anyone
else claiming allowances, even the actual owner, who is treated as not being
the owner of the asset for capital allowances purposes.
- Section 67 CAA 2001 was amended in Finance Act 2006 to ensure that where,
as in DSO arrangements, there are two or more agreements then the agreements
have to be viewed as parts of a single contract for the purposes of section 67
- We therefore consider that where DSO arrangements are entered into for
assets that qualify for plant and machinery allowances then the buyer (lessee)
is entitled, once the plant or machinery is brought into use, to claim plant
and machinery allowances on all of the future capital payments to be made
under the arrangements. No other person can claim allowances on these assets.
What are the capital gains implications of DSO arrangements?
- In relation to both taper relief and indexation allowance the prime issue
is the time when the buyer is treated as acquiring the asset in question.
Where DSO arrangements take the form outlined above, HMRC’s view is that –
unless there are any special features of the arrangements which lead to a
different conclusion – the buyer should be treated as acquiring each
successive tranche of beneficial interest at the time he or she entered into
the unconditional contracts with the seller and the financial institution for
acquiring their respective beneficial interests in the asset. This follows
from section 28(1) of the Taxation of Chargeable Gains Act 1992 (TCGA 1992).
- Taper relief applies when calculating amounts chargeable to capital gains
tax for individuals, trustees and personal representatives. Taper relief
applies by reference to the period for which an asset is held. That period
begins with the time when the asset was acquired for capital gains tax
purposes (or 6 April 1998 if later). Where section 28 TCGA 1992 fixes the date
of acquisition as the date DSO arrangements were entered into, taper relief
may run from that date on the whole of the gain arising on a later disposal by
- Indexation allowance is generally calculated on the allowable cost of
acquiring an asset from the month in which the asset is treated as acquired.
In the case of shares pooled in a ‘section 104 holding’, indexation runs from
the month in which expenditure enters the pool. This means that, where section
28 TCGA 1992 has the effect of fixing the date on which expenditure is treated
as incurred as the date the DSO arrangements were entered into, the whole of
the buyer’s allowable cost will be indexed from the month in which he enters
into those arrangements.
- Note that the allowable cost of the asset for capital gains purposes will
exclude any income items such as the rental payments under the leasing
agreement with the financial institution.
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© Crown Copyright 2007.
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Article Published/Sorted/Amended on Scopulus 2007-03-21 22:18:03 in Tax Articles