HMRC has issued amended draft legislation on compensating adjustments following feedback from a technical consultation on proposed changes to the transfer pricing code which would remove a tax avoidance opportunity on arrangements involving the 'compensating adjustment' rules.

The consultation, which closed on 18 September, outlined proposals to withdraw the ability of individuals to claim compensating adjustments where the counterparty to the transaction is a company.

Two changes to the original proposals have been made in response to the consultation responses, both relevant only to excessive leveraging arrangements. A technical explanation and revised draft legislation have been published to set out the final position incorporating these amendments.

The first change provides that the excess interest (over an arm's length amount) is to be characterised for income tax purposes as a dividend, meaning that the excess will be taxed at dividend rates rather than at rates applicable to interest reflecting the fact that the excess amounts perform in substance an equity function in the company.

The second change concerns the treatment of interest accrued but not paid at the time that the legislation takes effect. Respondents argued that it would be disproportionate for those amounts to be affected by the proposed changes, and that not exempting accrued interest would give rise to market distortions and unfair differences in tax treatment based purely on a company's ability to access a limited funding pool. The draft legislation therefore clarifies that interest accrued but not yet paid out will not be affected.

The draft legislation giving effect to the changes to the code is intended to be included in Finance Bill 2014. The changes will take effect from 25 October 2013.

More details are available from Gov.uk HERE