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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: introduction: the aims of thin cap work

Thin cap casework means either

  • undertaking an enquiry into a return, or
  • negotiating an Advance Thin Capitalisation Agreement (ATCA), a forward agreement- (see INTM520000), which gives a group certainty about the application of the legislation to the UK borrower for the duration of the agreement.

To assess whether and to what extent a company is thinly capitalised, it is essential to understand the activity of the company, its longer-term plans and prospects, and how it manages and structures its finances.

The object is to determine whether the conditions add up to an arm’s length provision, and adjust the tax computations where they do not. The best way of achieving this is by eliciting the detailed facts and discussing the issues face-to-face with people who know the company finances inside out. If the borrower has come to HMRC for an ATCA, there should be a high degree of co-operation. The aim is make any necessary adjustments to current and past years, and to agree what measures and conditions to apply for each year of the agreement to identify any non-arm’s length (disallowable) interest. The company then applies the agreement and complies with the outcome. See INTM515000.

An HMRC enquiry into a return will often lead to an application for an ATCA, so that the work done has a future benefit for both parties. ATCA work tends to take place in real time, around the time of the borrowing or refinancing.

An ATCA is made under the Advance Pricing Agreement legislation (s218 TIOPA 2010) and can only deal with “matters” listed in that section, in this case transfer pricing, and the ATCA process is aimed specifically at thin cap. The anti-arbitrage legislation has its own clearance procedures or unallowable purpose legislation - see INTM597510. In practice, as well as looking at the different aspects of borrowing listed in INTM511010, it is advisable to watch for other issues such as:

  • Checking that the company is getting an arm’s length return on any money which it is lending out (perhaps to a connected company) and imputing interest under the transfer pricing legislation if it is not;
  • Checking that the company is not accumulating cash while leaving debt outstanding (or has good commercial reasons for retaining cash );
  • Checking for financial avoidance, such as loans with a non-business purpose, or use of arbitrage opportunities, though it may not be possible to tackle them yet;
  • Watching for issues such as treaty shopping, where the lender claims treaty benefits to which they are not entitled, such as entitlement to interest without deduction of income tax - see INTM504000.
  • More generally, ensuring that Treaty clearance has been applied for to allow the payment of interest gross - see INTM413190 

The chapters that follow deal with a number of broad themes:

  • Understanding the business and recognising problems with the funding structure;
  • Understanding the terms and methods for measuring thin capitalisation;
  • Understanding the format which agreements take, and framing an acceptable and workable agreement;
  • Negotiating terms which will set the parameters for measuring the arm’s length amount of interest each year for the duration of the agreement;
  • Understanding what to do when an agreement runs into trouble or the parties cannot reach agreement.