Debt cap: intra-group short-term debt: examples of long-term funding purpose
This guidance applies to worldwide group periods of account ending before or straddling 1 April 2017.
Cases likely to fall within the exclusion for arrangements with a long-term funding purpose
In applying regulation 3 of SI2009/3313, the funding requirement is considered at the date it is made - is it reasonable to expect at the outset that the finance arrangement will be settled or terminated within 12 months? This will be a question of fact in any particular case. The examples below, and those at CFM92130, are intended to be no more than indicative.
A funding requirement is not short-term if it is expected to be repaid from other borrowings which extend the funding requirement beyond twelve months. Suppose, for example, a company enters into a new product market and expects to incur losses for the first two to three years of trading. It borrows by way of 6-month fixed term borrowing from its parent company in steadily increasing amounts until it starts profitable trading during year 3, at which point the amounts being borrowed start to decline.
All of these loans have a long-term purpose, which is to fund loss making trading over a period of years. It would not be reasonable to expect the company to repay existing borrowing and refrain from further borrowing while it is still making losses. Where the funding requirement is for a long-term purpose then all loans that meet the purpose are long-term loans.
A funding requirement is also not short-term solely because funds will become temporarily available that enable a loan to be repaid. Thus suppose a company borrows funds from another group company in January 2012 to fund a dividend. In December 2012 it receives a dividend from its subsidiary, which enables it to repay the loan. The following January it borrows a similar sum to fund the subsequent year’s dividend. This process repeats over many years. This company has a long-term funding requirement, which eases each year as it temporarily holds funds before distributing them to its parent. None of the loans from its fellow group company are short-term.
A UK company continually borrows from its overseas subsidiary which is very cash generative. The UK company uses the money to pay dividends to shareholders, buy back shares and make additional contributions to the group’s pension scheme. The loans from the subsidiary are all short-term notes, of three months in duration, and are continually rolled over and increased. The UK company could clear its borrowing requirement by asking the subsidiary to pay its surplus cash up as dividends, but chooses not to do so, perhaps because of the tax arbitrage opportunities for the group. The UK company has a long-term funding requirement.
Company X issues 5-year loan notes to fellow group company Y on 1 September 2013, in a period of account of the worldwide group ending on 31 December 2013. In the following period of account, company X becomes insolvent and Y decides to release it from its debt; thus, on 15 May 2014 the loan notes are cancelled. The assessment of whether a long-term funding purpose is present must be carried out as at 1 September 2013. The fact that company X issued 5-year notes suggests that it had a long-term funding need, and it would not have been reasonable at that time to expect that the loan relationship would terminate within 12 months even though, in the event, it did. Companies X and Y cannot therefore make a section 319 election in respect of the loan notes.