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HMRC internal manual

International Manual

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Transfer pricing: the main thin capitalisation legislation: Evolution of the thin capitalisation legislation - interest re-characterised as a distribution

Interest with a business purpose payable by a UK company would ordinarily be tax deductible under Part 5 of CTA 2009 (formerly Case III of Schedule D).

However, if:

  • prior to 28 November 1994, that interest was payable by a UK company to an overseas lender which had a 75% ownership of the borrower, or both borrower and overseas lender were 75% owned by another overseas company, or
  • between 29 November 1994 and 31 March 2004, that interest was payable by a UK company to a lender not within the charge to corporation tax, which had a 75% ownership of the borrower, or both the lender (outside the charge to corporation tax) and UK borrower, were 75% owned by another company,

then the amount of interest which exceeded what would be payable at arm’s length (and for the earlier period, possibly the whole amount - see INTM413020) would be re-characterised as a distribution.

This meant that, following ICTA88/S208, those payments could not “…be taken into account in computing income for corporation tax”.

Interest re-characterised as a distribution was no longer interest, so did not carry an obligation to deduct withholding tax under ICTA88/S349 (now ITA07/S874). Instead, the payer of a distribution had to account for Advance Corporation Tax (ACT) on distributions, at a rate of between 20% and 30%, until that was abolished with effect from 6 April 1999.