INTM413160 - Transfer pricing: the main thin capitalisation legislation: Claims to compensating adjustments for guarantors

Claims under TIOPA10/S192

This concerns deductions which may 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. The disallowance must have taken place through the operation of TIOPA10/S153 (Para 1B).

If it is established that a UK borrower is thinly capitalised, with excessive interest deductions compared to the arm’s length position, then its non-arm’s length interest costs will be disallowed in its tax computation. This gives the potential for double taxation, since the lender will have a receipt of taxable interest, for which the borrower is no longer receives a corresponding deduction from its taxable profits.

At arm’s length, if a borrower is unable to meet its commitments under the loan and the loan is guaranteed, the guarantor will normally have to take on the borrower’s interest payments and would be able to seek a tax deduction. A TIOPA10/S192 (previously ICTA88/SCH28AA/PARA6D) claim works in the same way for tax purposes, without requiring that the guarantor actually pays the interest, where the guarantor and the borrower are connected companies. Neither does it require that the borrower actually fail its obligations under the terms of a loan. The only trigger is the effect of applying the arm’s length principle through S153.

If between them the borrower and guarantor are able to claim tax deductions for all of the interest receivable by the lender, then double taxation is eliminated, though this depends on how much borrowing capacity they have between them.

The ability of the guarantor to support the increased borrowing represented by the claim must be measured using the same sort of arm’s length tests that would be used for a thin capitalisation review. In other words: could and would the guarantor borrow the revised amount (along with its own debt) at arm’s length? This question should be evaluated in terms of the characteristics of the guarantor, not those of the original borrower, and account would need to be taken of issues such as commitments already entered into. For example, a subsidiary which has already supported its parent’s borrowing from a third party, say by guaranteeing a debenture, will have reduced its ability to then provide a further guarantee to a fellow subsidiary under S192; its assets will be, to an extent, pledged elsewhere.

Compensating adjustments are only available for domestic guarantees, since in order for HMRC to give effect to a guarantor’s claim, HMRC must have the power to allow the computational adjustment against the guarantor’s profits.

The specifics of a S192 claim

The claim may be made by the guarantor, two or more guarantors acting together, or by the borrower (here called the issuer) acting on behalf of the guarantor (S194(1)). It works by treating the guarantor for tax purposes as if it has taken on some part of the costs of the loan which was subject to a transfer pricing disallowance in the hands of the borrower. TIOPA10/S192(1) says:

On the making of a claim, the guarantor company is, to the extent of borrowers the transfer pricing disallowance, to be treated for all purposes of the Taxes Acts as if it (and not the issuing company)—

  1. had issued the security,
  2. owed the liabilities under it, and
  3. had paid any interest or other amounts paid under it by the issuing company.

What this means in practice is that the guarantor’s own indebtedness is treated for tax purposes as having been increased by the amount of the borrower’s debt in relation to which the claim is made.

The “for all purposes of the Taxes Acts” condition includes withholding tax and treaty clearance issues - see INTM413190 onwards - but that does not mean that the purpose of the debt is subject to change. It would be absurd to invent a new purpose for the debt that was somehow more in keeping with the character and circumstances of the claimant company.

Time limits

The claim is subject to the same timing rules as S174, so that a claim cannot be made until the amount of the disallowance has been determined. This must be established either in the borrower’s Tax Return, or in a notice issued to the borrower (S194 (3)).

If a TIOPA10/S192 claim is made within the former period, and is followed by a notice issued to the borrower changing the arm’s length position, the UK guarantor has two years from the day on which that notice was issued to amend its claim.

These time limits are subject to TIOPA10/S186(3) (formerly FA98/S111(3)(b)) which provides for a time extension in certain circumstances.

More than one UK guarantor

If there is more than one UK guarantor, the sum of the adjustments made across all of their tax computations shall be no greater than the amount disallowed in the borrower’s tax computation (TIOPA10/S192(3)).

When there are two or more UK guarantors the claim must be made by all of the guarantors in combination, in accordance with TIOPA10/S194(1)(b).

This legislation refers only to guarantors who wish to make a claim. Companies which could claim but do not wish to need do nothing.

The legislation is applied year on year, in the sense that the list of potential claimants is not fixed at the time the loan is made, allowing companies to seek to establish a claim if they meet the criteria during the life of the loan.

The separate entity principle and guarantee claims

TIOPA10/S192 claims cannot be made by or on behalf of UK guarantors

  • which are subsidiaries of the borrower and
  • whose income, assets and liabilities are taken into account when determining how much the borrower could and would borrow (INTM413070).

The value of the subsidiaries will already have been taken into account when determining the borrower’s borrowing capacity, and if the possibility of a S192 claim has come up, it means that the borrower is thinly capitalised after the value of these subsidiaries has been recognised. This means that there can be no remaining value in its subsidiaries which could be argued to provide a guarantee such as would merit a claim under S192. Their borrowing capacity has already been exhausted.

The rules setting out how guarantees between connected companies affect thin capitalisation questions, and the rules setting out factors for consideration when evaluating how to treat guarantees are at INTM413110.