Financial Resource

used to purchase capital assets rather than as working capital .

Secondly, relief is not available for interest payable in the currency of a country outside the Scheduled Territories when it is payable either to a company which controls or is controlled by the UK company liable to make the interest payments or to a company which is under the control of a third company which also controls the UK company. This refusal to allow inter-group interest payments is an obstacle to foreign borrowing in cases where, for good practical and business reasons, a foreign subsidiary, having acted as the primary borrower from the foreign lenders with the guarantee of the UK parent company, relends the proceeds of the foreign currency loan to its UK parent company on the same terms as those applicable to the underlying loan. The subsidiary/parent company loan can be made on a short-term basis which could be renewed year by year so that the interest would qualify as “short interest” and therefore be allowed against corporation tax. However, this would not be satisfactory in the case where the foreign lenders wishes to take security by a charge on the parent company’s indebtedness to its foreign subsidiary. Also, there is some doubt whether a 360-day loan between parent and subsidiary, which is renewed year after year, would be regarded as a short-term loan .

Thirdly, to obtain relief, the interest must be paid to a non-resident. It is not practical for UK issuers of foreign public bonds to obtain evidence of residence from persons who obtain payment of interest at paying agencies outside the UK. The Inland Revenue will not unconditionally accept that interest paid in those circumstances is in fact paid to non-residents and cases have been known, to mark their position, where the Inland Revenue only allow 99% of the interest payments to be charged against corporation tax. This position is inequitable and penalises the UK borrower for a situation over which it has no control. It seems to fail completely to recognise the exchange control and paying collecting agent tax regulations relating to the holding by residents of the UK of foreign currency securities. Under those regulations, a UK resident can only hold foreign currency securities through an authorised depositary and upon receipt by the relevant bank of any interest or dividend payments the bank is obliged to deduct and account for any applicable UK income tax .

C. Public Sector and nationalised industry foreign currency borrowing

(1). Introduction

1969 was facing a difficult liquidity situation in which, the Treasury had favoured for some time steps to enable public and private borrowers to borrow foreign currencies in the Euro-bond market. This was a means of meeting some of their financing requirements and, at the same time, of increasing the nation’s reserves. However, the issue of tax was causing some problems with the British government.

The issue in which a local authority may be able to pay interest gross on an issue of bearer bonds denominated in foreign currency was a welcome opportunity, as if this was accepted, it was likely that one local authority, the GLC, would begin negotiations. The Bank of England took the view that it was advantageous that the first Euro-bond issue by a public borrower was the GLC. Due to this reason, they wanted to get the position on the tax difficulty cleared up as soon as possible. Their understanding seemed to be that, since GLC borrowing would be secured on a domestic asset (the GLC rate revenues), it would not qualify for the permission to pay interest gross conveyed in the 1968 Finance Act.

It was clear that there was a genuine obstacle standing in the way of GLC and other local authorities borrowing foreign currency abroad, and it was necessary to consider means of removing an impediment to foreign currency borrowing by UK local authorities in the Euro-bond markets. It was suggested that the required provision should be generalised in order to cover nationalised industries or private sector borrowers as well as local authorities; to cover a direct charge on UK assets as well as the indirect one that arised from a subsequent loan contract, which was the particular problem of local authorities; and to limit the arrangements to foreign currencies, excluding currencies of the Scheduled Territories. Looking at the tax position on foreign borrowing – any UK borrower wishing to tap sources of funds in the international capital markets needs to take into account the following two points:

(a.) He will have to contrive a means of paying interest to the lenders gross without formality, because this is a demand of lenders in the international capital markets.

(b.) He will naturally wish to be able to charge the interest payable on his borrowing as an expense for the purpose of UK tax assessments.

(2). Payment of interest gross

Euro-bond issues were not practicable unless the borrower undertook to pay interest gross, and it was therefore important to be clear as to the terms on which London, other local authorities and the nationalised industries could arrange borrowing on gross terms. It was possible for a local authority or nationalised industry to arrange to pay interest gross, without attracting any UK tax charge, provided that the interest has an overseas source in the hands of the bond-holder . This interest has an overseas source if; firstly the loan contract is made abroad, secondly if the loan contract is governed by foreign law, thirdly if the interest is payable abroad, and there is no UK paying agent. Finally if the loan is not secured on any specific assets or revenue in the UK.

The Revenue had to consider all the specific arrangements before they took a final view that it takes the relative interest outside the UK tax charge. In their sterling borrowing hitherto, the local authorities had secured their loans on their revenue, largely from rate income. The fourth condition would preclude this. On the basis of the forth requirement being fairly inflexible, there was no means by which the local authorities could secure their loans (if for good reasons they wished to do so) on any assets or income in the UK .

It was important to clarify the point of whether there was any difficulty for the GLC in making a Euro-bond issue provided that the borrowing contract was signed abroad. To enable the authority to pay interest gross, to give the interest a foreign source, it was necessary for the four conditions to be met. The fourth condition was of extreme concern – the provision that the loan should not be secured on any specific assets or revenue in the UK. The concern was that the GLC and other local authorities almost invariably secured their sterling borrowings of rate income, they would wish to do the same in the Euro-bond market, and the fourth provision would effectively preclude them from paying interest gross. It was far from clear that it would be necessary for the GLC or any other local authority to offer a lien on the rates if they undertook a Euro-bond issue .

It seemed that, it was almost certainly necessary to give an indirect lien in the following way. On the basis that the loans to the cities Oslo, Bergen and Copenhagen being regarded by the bond market as the relative precedents, it was necessary for the GLC to give a negative pledge to the effect that if on any subsequent borrowing a security is given, then this security will be available equally for the bond issue. It seems likely, that if the fourth provision was indeed inflexible, then the negative pledge would also fall foul of the Revenue requirements, and it would not be possible for the authority to pay interest gross. This seemed like a very tiresome procedure which involved three possibilities; firstly the Revenue may conclude, on reflection, that the “revenue” to which reference is made; in the fourth provision (that the loan is not secured on any specific assets or revenue in the UK.) relates to trading income, and does not therefore cover the rate or other income of local authorities; there will therefore be no problem. Secondly, the law could be amended in the 1969’s Finance Act. Thridly, the local authorities might discontinue their practice of securing sterling loans against rate income .

However, this problem did not arise for the nationalised industries, because they did not, secure their loans on specific assets or income. The Chancellor of the Exchequer (on the 15th January 1969) approved the conclusion that foreign currency bond issues by nationalised industries were desirable as a contribution to Britain’s foreign currency financing problem, and that the Government should offer to carry the exchange risk so as to facilitate the making of such issues and other local issues . It was noted that the GLC might be debarred for tax reasons from making such issues. If local authorities were in fact debarred, or the GLC decided not to make an issue, it will not be worth extending this arrangement to local authorities as well as nationalised industries. It was finally decided that, if the GLC were not debarred and they have firm plans to make an issue, then the door can be opened to local authorities .

The obvious thing to do was for the local authorities to make an issue unsecured. It seems that unsecured borrowing was a normal procedure in Continental capital markets. However, the borrower was normally expected to provide a “negative pledge”. E.g., the Euro-bond markets may take some issues by the cities of Oslo, Bergen and Copenhagen as precedents. These cities borrowed without security, but provided a negative pledge to the effect that if on any

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