INTM414410 - Financial transactions: Guarantees
TIOPA10/S152 and S153 – Arm’s length provision where actual provision relates to securities
TIOPA10/S152 and TIOPA10/S153 have been repealed in order to more closely align UK transfer pricing rules for financial transactions with the 2022 OECD Transfer Pricing Guidelines (TPG). The repeal of these sections, combined with amendments to TIOPA10/S154 and the introduction of TIOPA10/S153A, ensure that the UK rules in respect of the treatment of financial guarantees aligns with the guidelines in Chapter X of the 2022 TPG.
The repeal of TIOPA10/S152 and TIOPA10/S153 will have effect for chargeable periods beginning on or after 1 January 2026. Guidance on the treatment of guarantees under TIOPA10/S152 can be found at INTM413100, INTM 413110, and INTM413120.
TIOPA10/S153A – Certain guarantees not capable of being arm’s length
Following the repeal of TIOPA10/S152 and S153, the effects of intragroup guarantees can be considered for the purposes of transfer pricing of intragroup financial arrangements.
The effects of a financial guarantee on the terms of lending between borrower and lender can be varied. The guarantee allows the borrower to borrow on the terms that would be applicable if it had access to the assets of the guarantor(s) in the event of the borrower’s default which may allow the borrower to borrow on more favourable terms. Where a guarantee reduces the cost of debt-funding for the borrower, at arm’s length the borrower might be prepared to pay a fee to the guarantor, provided it was in no worse position overall.
Borrowing with a guarantee might also affect terms and conditions of the loan other than price. Equally, the presence of a guarantee does not necessarily signify a change in the terms an arm’s length lender would be willing to lend on. A thorough analysis of the effects of the guarantee is essential for a transfer pricing analysis.
TIOPA10/S153A makes clear that a guarantee that increases the quantum of debt available to a borrower will never be deemed an arm’s length guarantee.
The underlying rationale for this rule is that the level of credit risk that the guarantor would assume in providing the guarantee of that additional amount is the equivalent credit risk that would have been deemed non-arm’s length for an independent lender to assume when evaluating the loan. If an independent lender would not be willing to assume the credit risk in making the loan, an independent guarantor would be equally unwilling to assume the equivalent credit risk.
Where TIOPA10/S153A applies, the provision of the guarantee is deemed to be non-arm’s length to the extent that an amount of borrowing would not have been lent between independent enterprises without a guarantee
the arm’s length provision of guarantee with be imputed under TIOPA10/S147. This applies to disallow the guarantee fee charged by the guarantor on the amount of non-arm’s length borrowing. Consequentially TIOPA10/S147 will also apply to the borrowing provision, restricting the amount of lending to the arm’s length provision.
With the introduction of the UK-to-UK exemption, outlined at INTM414200, where the provision for the guarantee qualifies for the UK:UK exemption, then the potentially advantaged person is not required to calculate their profits and losses as if the arm’s length provision had been made or imposed instead of the actual provision. There is no requirement to apply TIOPA10/S153A in respect of that guarantee and TIOPA10/S147 does not apply to restrict the effects of the guarantee in imputing the arm’s length provision, and in turn, does not restrict the quantum of loan under the borrowing provision.
This is subject to the condition that the guarantor has sufficient borrowing capacity and assets available to provide guarantee of the additional quantum.
Example 1 – Case where UK:UK exemption does not apply
UK resident Company A borrows £100m from related party Company B at an interest rate of 6%, with UK resident related party Company C providing a guarantee to Company A on the loan.
At arm’s length Company A would only have been able to borrow £20m at an interest rate of 6%. However, the guarantor has sufficient assets and cashflow for the guarantee to increase the quantum of borrowing available to Company A to £100m and to reduce the interest rate to 4%. No guarantee fee is paid.
Assume that the provision of the guarantee is not a qualifying provision under the UK-to-UK exemption, for example, because elections have been made under TIOPA10/S164A(6).
In relation to the guarantee of the £80m that would not have been lent between independent enterprises but for the guarantee, the guarantee would automatically be considered non-arm’s length under TIOPA10/S153A. In relation to the remaining £20m of lending, a guarantee fee would generally be payable at arm’s length, which may be as high as 2% on the £20m of lending (£0.4m). Thus, under the arm’s length provision, Company C would have guaranteed £20m of borrowing in exchange for a guarantee fee.
If there is a potential advantage in relation to UK taxation, Company A and Company C must therefore calculate their profits and losses as if a guarantee of only £20m of borrowing had been provided in exchange for a guarantee fee. This includes Company A applying TIOPA10/S147 to the provision of the £100m loan to it on the basis that the guarantor is only liable to ensure the lender receives payment of £20m of borrowing (i.e., the amount that would have been lent between independent enterprises even without a guarantee). The remaining £80m of borrowing (ie, the amount that would not have been lent but for a guarantee) is therefore treated as non-arm’s length as it is not protected by the guarantee. In determining the interest rate on the £20m of borrowing, the effect of the guarantee to reduce the interest rate to 4% is taken into account.
Both Company A and Company C do indeed have a potential advantage in relation to UK taxation, as a smaller amount would be taken for tax purposes to be the amount of their profits under the actual provision in comparison to the arm’s length provision:
Company A borrowed £100m at 6% from Company B under the actual provision, giving rise to interest expense of £6m. Under the arm’s length provision where a guarantee is only provided in relation to £20m, it would only have been able to borrow £20m at 4%, giving rise to interest expense of £0.8m. It would have paid a guarantee fee of up to £0.4m. This amounts to £1.2m of deductions in total under the arm’s length provision compared to £6m under the actual provision.
Company C received no income under the actual provision for the provision of a guarantee, whilst it would have received a guarantee fee of up to £0.4m under the arm’s length provision.
Company C may be able to make a claim under TIOPA10/S192. See INTM413160 and INTM414530 for guidance on this issue.
Example 2 – Interaction of a financial guarantee with the UK-to-UK exemption
Assume the facts are the same as in Example 1, save that the provision of the guarantee is a qualifying provision under the UK-to-UK exemption.
This means that neither Company A nor Company C is required to calculate their profits on the basis of the assumption at TIOPA10/S147 that the arm’s length provision has been made or imposed (which, as set out above, is that only £20m would have been guaranteed in accordance with TIOPA10/S153A, and that a guarantee fee may have been chargeable in relation to that £20m guarantee).
Directly in relation to the provision of the guarantee by Company C to Company A, no fee for the guarantee can be imputed in Company C (and accordingly Company A has no access to a compensating adjustment under TIOPA10/S174).
In relation to the provision of a loan from Company B to Company A, this means that Company A is not required to calculate their profits and losses on the basis that only £20m has been guaranteed, but may do so on the basis of the actual provision (a guarantee in relation to the full amount of the loan). As a result, the full amount of borrowing, £100m, can continue to be recognised in Company A under the borrowing provision.
Under these circumstances no claim may be made under TIOPA10/S174 or S192 by either the lender or the guarantor respectively, as the arm’s length provision has not been imposed in respect of the advantaged person under the borrowing.