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HMRC internal manual

International Manual

HM Revenue & Customs
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Transfer pricing: the main thin capitalisation legislation: Evaluating guarantees: starting with the arm’s length cost of debt

Adjusting for the presence and effect of guarantees

TIOPA10/S153 (SCH28AA/Para 1B) is about considering the effect of, and consequently the issue of allowing the costs of pricing guarantees between connected companies. It adopts a similar approach to the way transfer pricing of securities between companies operates - see TIOPA10/S152 (INTM413100). However to understand how the section works it is better to start by looking at the factors that have to be disregarded before looking at the factors that are specifically to be taken into account.

TIOPA10/S153(4) has the same effect for guarantees as TIOPA10/S152(4) has for loans. It ensures that where the guarantor is not generally in the business of making guarantees, that circumstance cannot be taken into account when evaluating what the guarantee fee would be at arm’s length.

TIOPA10/S153(5) and (6) ensure that guarantees from connected companies are ignored, so that the borrower’s borrowing capacity is evaluated on a separate entity basis (INTM413070). These subsections repeat what was said at TIOPA10/S152(5) and (6), except with different intent. S152 is about how the arm’s length provision is calculated for the borrower, for the purposes of testing whether a security is on arm’s length terms. S153 repeats the same test, but as a precursor to working out whether a guarantee has an arm’s length value to the borrower. The exercise should isolate and exclude the effect of the guarantee to identify what would have been achieved without it.

Looking at the loan whilst ignoring the effect of any guarantees establishes the amount the borrower would have been able to borrow in its own right, and the terms on which it would have done so. The legislation specifically states that guarantees should be disregarded in considering the following specific issues:

  • the level or extent of overall debt
  • whether a loan would have been entered into
  • the rate of interest or other terms

Once this is established, the legislation considers the transfer pricing of the guarantee fee itself - see INTM413110.