The original loan relationships rules issued by the UK government in the 1990s modernized the treatment of debt instruments by aligning the tax treatment more closely with the accounting treatment. However in the meantime the financial world has changed considerably with the introduction of new types of financial instrument and the further blurring of boundaries between debt, equity and derivative instruments. The applicable accounting standards have also been modified.

Some departures from the accounting treatment are still needed. The consultation document points out that the accounting treatment may not necessarily reflect the legal form of a particular transaction. Another situation that may arise is that amounts included in the financial statements may be affected by another instrument or transaction that does not fall within the scope of the loan relationships rules.

In addition to all this, the types of financial instrument covered by this legislation have frequently made an appearance in artificial tax avoidance schemes. There have been piecemeal changes to the tax law to modernize the legislation and close the loopholes, but this has introduced further complexity and lack of transparency which have in turn created further loopholes that are exploited by the tax avoidance industry.

The consultation document does not propose to change the definition of a loan relationship or derivative contract. However it aims to clarify the aims of the legislation, explain the role of the accounting figures in arriving at the final taxable amounts, and show the reasons for the exceptional circumstances in which the tax treatment has to depart from the normal approach. The aim of re-aligning the tax regime with the accounting approach should reduce the need for adjustments in the tax computation and reduce tax volatility. The proposed changes would integrate the loan relationships and derivatives regimes, revise some of the detailed provisions of the law and introduce a comprehensive anti-avoidance provision that would be integrated with the new general anti-abuse rule (GAAR) in the UK tax legislation.

The consultation period ends on 29 August 2013. The legislation would be introduced in two stages, in the Finance Acts 2014 and 2015. The changes in 2014 would be concerned with areas where the government believes that tax is currently being lost, while the more comprehensive changes would be introduced in Finance Act 2015. A more detailed consultation would be held in 2014 on the measures to be introduced in Finance Act 2015.

The rules to be updated in Finance Act 2014 would include the provision in respect of companies that are members of partnerships; the bond fund rules that look at whether income from assets held in some types of investment fund arises from the loan relationship rules; and the tax exemptions relating to index-linked gilts. The 2014 update would also include the unallowable purpose rules, which exclude from the computation of taxable income or deductions amounts arising from a non-commercial purpose of the company.