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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: measuring debt: what is equity?

For thin cap purposes, the equity of a company includes the issued ordinary share capital, the retained profits of the company and other reserves (see provisos below) attributable to equity shareholders.

As was done with debt in INTM517020, it is useful to look at accounting descriptions of items included in capital and reserves.

Capital & reserves accounts item Comment
Called-up share capital (ordinary shares) Include as equity.
Preference shares These are unlikely to be included in capital and reserves in a set of UK GAAP or IFRS compliant accounts because the characteristics of preference shares are usually more akin to a financial liability and therefore accounted for as a creditor. These shares should only be included in equity if they are in substance equity, for example, there may be no obligation to pay a dividend or redeem the shares. Whether preference shares qualify as debt or equity should be clear from the accounts if they are UK GAAP or IFRS compliant.
Share premium account Include as equity.
Revaluation reserve Normally include as equity.
Note, however, a third-party lender may want evidence the revaluation is appropriate, so may require a valuation of company property to be performed by a qualified, independent valuer. This would be updated at intervals.    
  Capital redemption reserve A non-distributable reserve which is included as equity.
  Capital contributions A capital contribution is a contribution to the equity capital of a company. It is not a loan and creates no obligation to transfer economic benefit to the maker of the contribution. See INTM502050.
  Other reserves (in particular, goodwill) See ‘revaluation reserve’ above, and treat with caution, particularly where intangibles such as goodwill is concerned. HMRC takes the view that the value of goodwill is recognised sufficiently in profit projections, and goodwill reserves should not count as equity.
  Retained profits (or losses) The balance of accumulated profits/losses is part of shareholders’ funds. Losses will create or contribute to a negative balance which can reduce shareholders’ funds. When this balance falls below zero, the company is in negative equity.

You may encounter other reserves in this section of the balance sheet. If the accounts are UK GAAP or IFRS compliant, then these reserves are likely to be a component of equity.

See also information on the tax treatment of ‘interest-free loans’ at INTM517020. If either of these items is included in equity for thin cap purposes, it is advisable to record in the thin cap agreement that as a condition of the agreement they retain their status for the duration of the agreement.