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HMRC internal manual

International Manual

HM Revenue & Customs
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Transfer pricing: the main thin capitalisation legislation: Special rules for lending between companies

Corporate thin capitalisation rules

There are specific rules for thin capitalisation where the actual provision relates to lending between (or supported by) connected companies. These begin at TIOPA10/S152 (previously at TA88/SCH28AA/PARA1A), and inform how the basic transfer pricing legislation at TIOPA10/S147 should be interpreted for the provision of securities between companies.

Meaning of security

The term “security” suggests that the indebtedness is secured against the assets of the borrower, so that in the event of a default, those assets might be seized and realised by the lender. This security decreases the lender’s financial risk e.g. a mortgage. However the meaning is expanded by TIOPA10/S154:

Security” includes securities not creating or evidencing a charge on assets.

This widens the definition of security to include a loan or any other advance of money, irrespective of whether it is secured by a charge on the borrower’s assets or not. Therefore, a “security” in this context is simply an agreement in relation to debt, between the lender and the borrower. The agreement itself could range from the type of long, formal document likely to exist between a syndicate of lenders and a major plc, to a one-page informal agreement between members of the same group, to an understanding that trade debts will be left outstanding for longer than a commercial period. This is a matter of fact and degree, and lack of detail or formality is not evidence of the absence of a lending arrangement.

Factors taken into account when evaluating the security

TIOPA10/S152(2) specifically requires account to be taken of “all factors” when comparing the actual provision with the arm’s length provision. This is no more than a reiteration of the normal principles used to evaluate any transfer pricing provision: the “would” and “could” arguments mentioned in INTM413030. S152 goes on to say that these factors should include::

  1. the question whether the loan would have been made at all in the absence of the special relationship,
  2. the amount which the loan would have been in the absence of the special relationship, and
  3. the rate of interest and other terms which would have been agreed in the absence of the special relationship

Again, these are all factors which would be considered by independent parties acting at arm’s length, at the time when the provision was made. The legislation uses the term special relationship, which refers back to the participation condition explained in INTM412020.

Factors to be disregarded when evaluating the security

TIOPA10/S152(4) ensures that the fact that the lender is not generally in the business of making loans cannot be taken into account when evaluating the terms.

TIOPA10/S152 (5) and (6) ensure that the existence of a guarantee from a connected party is effectively ignored when evaluating what could and would be lent at arm’s length. It specifies that the existence of a guarantee should not be taken into account in determining of the arm’s length position for any of the following:

  • the appropriate level or extent of the issuing company’s overall indebtedness,
  • whether the loan would have been made at all
  • the rate of interest
  • the term of the loan
  • repayment terms
  • any other terms that might be expected to be applicable

This means that, for example, where the parent company of the borrower has substantial assets and income held in a separate sub-group, it may be able it to provide a guarantee to support the borrowing but that will be disregarded in thin cap calculations in respect of the borrower.

Further explanation of the specific rules relating to guarantees in TIOPA10/S153 is set out at INTM413110.