Beta This part of GOV.UK is being rebuilt – find out what this means

HMRC internal manual

International Manual

From
HM Revenue & Customs
Updated
, see all updates

Thin capitalisation: practical guidance: the Advance Thin Capitalisation Agreement process: setting up an ATCA

Components of a thin capitalisation agreement

Even where there is initial disagreement between HMRC and the UK group as to what constitutes an arm’s length provision (see INTM514040), a negotiated solution is achieved in virtually all thin capitalisation cases. The agreement will usually contain financial covenants (formulae for establishing the arm’s length amount of debt and interest each year) or conditions which are similar to - if usually simpler than - those negotiated with arm’s length lenders such as banks.

The agreement should record accurately and comprehensively what has been agreed. Experience shows that unless this is done, a substantial amount of time may be spent later on, arguing about precisely what had been agreed, particularly if the terms agreed are spread over a number of pieces of correspondence and meeting notes. All the terms should be gathered in one place, within the agreement and its appendices. If it is necessary to refer to material outside the agreement, that material should be clearly identified within the agreement and appended to it.

A Model ATCA agreement (the text of which is included from INTM520090) may serve as a template in straightforward cases. This can be adapted to suit the individual circumstances of specific cases. HMRC is not likely to insist on this template being used, but it does indicate what might be broadly acceptable as a format, and what elements HMRC would like to see in the agreement.

It is preferable that the applicant draws up the agreement. A draft can be fine-tuned until the wording is agreed. This latter part of the process should not be drawn out by either side with a series of minor “tweaks”; changes from previous drafts should be clearly highlighted and if necessary explained.

It is impossible for a template to cover every eventuality in a particular case, and very specific clauses may be needed to accommodate particular circumstances. If an unusual feature is requested or required by either party to the agreement, it can be discussed with a specialist, but broadly whatever works for both parties is acceptable.

Experience has shown that there are certain elements which, if they are not included in the agreement, tend to cause difficulties if there is a potential breach of the agreement. Therefore an agreement should normally include:

  • a statement of the maximum amount of total borrowing - a debt cap. This is particularly useful, since the separation of thin cap and treaty clearance means that once the agreement is signed off there is no means of alerting HMRC about further borrowings. Depending on the case, this cap might include a certain amount of headroom over and above the amount currently borrowed, to allow further borrowing to take place without breaching the agreement. This may be accompanied by a note of the circumstances where this might happen, for example specifying that further acquisitions may be made funded half by debt and half by equity, so long as the other conditions of the agreement continue to be met.

Alternatively, the ATCA may be limited to debt in existence at the time of the agreement. This may be appropriate where funding is at a maximum in the wake of a major acquisition or where the agreement request concerns a private equity case where the funding is clearly defined at the outset. Further borrowing would then require a further discussion and possibly further application.

  • the interest rate(s) - see INTM516030 
  • the duration of the agreement, usually 3-5 years - see INTM520040 onwards,
  • definitions of the financial covenants which will set the limits of arm’s length borrowing each year, with a year-by-year list of the covenant values - see INTM512075 onwards.
  • the agreed consequences of each covenant being met each year - see INTM520050 
  • the agreed consequences of a breach in one or more covenants - see INTM520060 
  • the process for monitoring an agreement with, if appropriate, an example of how the evidence will be presented and calculations made each year - see INTM520080.