Debt cap: gateway test: definition of relevant liabilities - short and long term borrowings
Relevant liabilities for the purposes of calculating the worldwide gross debt and UK net debt amount
The term relevant liabilities is used to identify amounts that make up the worldwide gross debt and the UK net debt amount. In both cases they are amounts disclosed in either the balance sheet of the consolidated financial statements of the worldwide group or the balance sheet of the financial statements of a group company. In either case a relevant liability is a borrowing, whether by way of overdraft or other short term or long term borrowing (see TIOPA10/S263(3) and S264(2) Part 7), or a liability in respect of a finance lease (see TIOPA10/S263(3)(b) and S264(2)(b)).
The inclusion of overdrafts or other short term or long term borrowing, is related to the accounting standards under which the financial statements are prepared. For identifying relevant liabilities that make up the UK net debt amount, this means generally accepted accounting practice, which FA2004/S50 defines as either IAS or UK GAAP. For identifying relevant liabilities that make up the worldwide gross debt, this means accounting standards that are used to prepare ‘acceptable financial statements’ (see TIOPA10/S347 (3) .
Accounting standards do not state explicitly whether a particular liability is a borrowing; neither IAS nor UK GAAP have a specific definition of what constitutes a borrowing. However, accounting standards clearly expect amounts of borrowing to be identified and if appropriate, specifically presented in financial statements (either at the consolidated or sole company level).
IAS, for example, clearly expect such amounts to be identified; statements of cash flows have to show repayments of amounts borrowed and proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings. Both group consolidated financial statements and company financial statements will often identify short-term and long term borrowings in notes included in the financial statements. While in certain cases a company might not be required to include a cash flow statement in its financial statements, this does not detract from the fact that the accounting standards provide for borrowings to be identified in cases where such a statement is required.
Example of short and long term borrowings that are relevant liabilities
The type of borrowings that would be treated as relevant liabilities are as follows:
- loans, debentures, discount notes, promissory notes, bonds, mortgages or any other financial instrument that creates or acknowledges indebtedness by one party to another.
- Repurchase agreements, more commonly known as repos, are a particular form of borrowing, allowing a borrower to use a financial security as collateral for a loan of money at interest. A repo accounted for as a collateralised loan is a relevant liability.
- Shari’a compliant arrangements that are economically equivalent to borrowing, such as sukuk.
- For most companies, trade creditors are not relevant liabilities, even if interest is charged on those debts - the debt arises because the company has bought goods or services, not because it has borrowed. However for financial services companies, trade creditors that arise from amounts borrowed or finance leases will be relevant liabilities.
- Liabilities in the form of share capital, such as preference shares, are not treated as relevant liabilities for the purposes of the gateway test, even if they are accounted for as financial liabilities.
Relevant liabilities of banks and other financial institutions
While all groups need to borrow money at some time (even if just a bank overdraft), banks and other financial services involved in the lending of money will borrow money in ways not open to other parties: for example, a company can only accept deposits from the public if authorised to do so by the regulator. Such borrowings are still relevant liabilities. Examples include customer deposits and subordinated debt that forms part of the regulatory capital of the worldwide group or relevant group company. However, if the worldwide group qualifies as a financial services group under TIOPA10/S266 it need not apply the gateway test (see CFM90800 onwards).
Relevant liabilities recharacterised in line with the arm’s length principle
In some cases a relevant group company may prepare accounts that show a particular liability as being a relevant liability, but in making its CTSA return it makes an adjustment to its profits under TIOPA10/PART4 to reflect the fact that, at arm’s length, the liability would not be debt on which interest is charged. For example where there are historic non interest bearing inter-company balances between active and dormant group companies.
For example, the balance sheet of a relevant group company might show an intra-group loan of £450 million and equity (share capital and retained earnings) of £50 million, but under an Advance Thin Capitalisation Agreement (ATCA) the company is only allowed a deduction for interest in respect of £250 million of the loan. The balance of the loan is treated as equity for the purposes of TIOPA 10/PART 4. In such a case, a relevant group company may exclude from its relevant liabilities so much of the loan as has been agreed with HMRC to be non arm’s length.
Similarly where a group does not have an ATCA but self assesses the transfer pricing adjustment, it may exclude from its relevant liabilities so much of the loan it considers to be non-arm’s length. In addition where the financing arrangements are re-characterised under the arbitrage rules in TIOPA 10/PART 6 a company may exclude so much of the arrangement as has been agreed with HMRC to fall within the arbitrage disallowance.