Transfer pricing: the main thin capitalisation legislation: compensating adjustments for lenders
What are compensating adjustments for thin capitalisation purposes?
Compensating adjustments are a means of restoring the neutral position across the UK tax net.
- They are available to the lender where the borrower has suffered a disallowance and there would otherwise be double taxation (no deduction for the borrower, but the lender taxed on the receipt) (see this page).
- They may also be available to UK guarantors, where the borrower has had interest disallowed and the guarantors can claim that they could have carried some part of the debt concerned (INTM413160).
Claims by lenders may be made before the quantum of the borrower’s disallowance is final, whereas a guarantor must wait until the disallowance is determined.
TIOPA10/S182 adjustments (previously Para 6C Sch 28AA)
Where there has been a transfer pricing adjustment disallowing interest in the computations of a UK borrower, a compensating adjustment may be available to the lender where they are within the charge to income tax or corporation tax. It is not obvious in the case of an overseas lender, but the requirement for the payer of interest to deduct tax at source from the non-arm’s length amount of interest brings the person to whom the interest is payable within the charge to income tax. It is the overseas lender’s income which is being taxed through the agency of the payer. However, overseas lenders will only claim under S182 to give effect to S187 (INTM413150).
The intention of the adjustment is that for UK tax purposes the lender, as well as the borrower, should be treated as if the arm’s length provision had been made. This means that if the interest deduction in the borrower’s computations has been reduced, the corresponding interest income in the computations of the lender will be similarly reduced. The relevant legislation starts at TIOPA10/S174 (formerly Para 6) with specific rules for claims where the actual provision relates to a security at S181-182.
Compensating adjustment claims where both parties are companies
In thin cap cases, the transfer pricing adjustment will have been in the computations of the borrower, restricting the interest deduction. It therefore follows that the party requiring the compensating adjustment will be the lender. A claim may be made by the lender or by the borrower claiming on behalf of the lender (S182(1)).
The claim may be made at any time before the date falling two years after the making of the return which incorporates the borrower’s disallowance, or alternatively, within two years of the notice which determines the amount to be disallowed. This means that a claim may be submitted before a computation has been submitted by the borrower, and adjusted later to reflect the amount of the disallowance which is finally agreed, say at the end of a thin cap enquiry.
The claim is subject to the provisions of TMA70/SCH1A, which means that the claim must specify an amount, stated as being to the best of the information and belief of the person making the claim. A claim with no such amount specified will be invalid.
In the event of a valid claim, all necessary adjustments shall be made to give effect to the claim, notwithstanding any time limits for the making of adjustments, as specified in S183.
A claim for a compensating adjustment must be made within two years of the date of the return, assessment or closure notice in which the actual amount of interest claimed has been restricted to the arm’s length amount. In a case where an enquiry results in a transfer pricing adjustment but the lender has already submitted a return for the relevant period then the lender will be able to amend their claim accordingly.
Compensating adjustment claims involving a non-corporate
In such cases, a claim may only be made by the disadvantaged person (the lender)
A claim may not be made under S174 unless the advantaged person (the borrower) has made a return, or received an assessment or closure notice, in which the actual amount of interest claimed has been restricted to the arm’s length amount.
The claim made by the lender must be consistent with the borrower’s return, assessment or closure notice.
The lender may make a claim within two years of the date the borrower’s return was made or within two years of the giving of the notice or assessment. In a case where an enquiry results in a transfer pricing adjustment, but the lender has already submitted a return for the relevant period, then the lender will be able to amend their claim accordingly.