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HMRC internal manual

International Manual

HM Revenue & Customs
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UK subsidiaries of foreign banks and foreign banks trading in the UK through permanent establishments: Transfer pricing legislation: Thin capitalisation

Prior to 1 April 2004 a company’s capitalisation would have been considered under the provisions of ICTA88/S209 (2) (da), ICTA88/SCH28AA and ICTA88/S808A where there was a Double Taxation Agreement containing a special relationship provision within the Interest.

From 1 April 2004 the transfer pricing regime was extended to cover thin capitalisation and the provisions in ICTA88/S209 (2)(da) ceased to have effect.

The thin capitalisation provisions apply to banks in the same way that they apply to any other business and general guidance on thin capitalisation can be found at INTM542000 onwards.

Bank regulation by the Financial Services Authority (FSA)

Banks and other financial institutions do differ from other businesses in that they are generally regulated by the FSA, and are required to meet minimum regulatory capital requirements. Whilst these capital regulations provide a framework within which banks operate and set some constraints upon the capital structure that they adopt, the concerns of the regulator are unlikely to be the same as those of the tax authorities and there may still be thin capitalisation issues.

From an FSA supervisory perspective, regulatory capital provides a buffer that enables a bank to absorb losses without the interests of the depositors being adversely affected. However, from a tax perspective this may be a concern because a bank may adopt a capital structure that it would not have if it funded itself entirely at arm’s length, and so both the terms and the amount of the subordinated debt may require further consideration.

When looking at the capitalisation of a bank, or other financial institution, that is wholly or partly funded by associates, the focus will generally be on whether it would have chosen to fund itself in such a way at arm’s length instead of focusing on whether or not it could have done so.