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HMRC internal manual

International Manual

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HM Revenue & Customs
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Thin capitalisation: practical guidance: private equity: applying the transfer pricing rules - “acting together”

Position for accounting periods starting on or after 4 March 2005

The provisions of TIOPA10/S158 onwards apply the transfer pricing rules where persons have participated indirectly in the management, control or capital - in the more familiar words of ICTA88/Sch 28AA/PARA4A, “acted together” - in relation to the financing arrangements of a company or partnership. The legislation is considered at INTM413180.

“Acting together” has a very wide meaning and it is unnecessary for a loan provider to have an equity interest in the borrower for the loan to be within the scope of the legislation.

In the context of a leveraged buyout, all of the finance providers involved in the transaction may be within the scope of the legislation, so each of the loans will need to be considered to determine whether they are lending on arm’s length terms. However, in normal circumstances, the risk of non-arm’s length lending is likely to be low where the loan is from a senior or mezzanine lender who is otherwise unconnected with the equity investors.

In practice, the more significant risk is that the shareholder debt may not be on arm’s length terms. However, there will be circumstances where non-shareholder debt may also need to be considered critically; for instance, where the buyout is part financed by loans from the vendor, or any loan that is, in substance, an equity investment. If the lending occurs as part of a deal in which the lender acquires or disposes of their shares, the implications of the lending and the share transaction happening at the same time should be considered.

Another scenario which requires careful consideration is where the borrower is in a distressed situation and subject to a financial restructuring, and as a consequence, either

  • a lender - who previously had no stake in the equity of a business, becomes an equity investor, or
  • an existing equity investor increases their stake as part of the restructuring.

In these situations a risk exists that the refinancing by the lender is influenced by their stake in the business and the lending is not an arm’s length provision.

Transitional rules for pre-4 March 2005 financing arrangements (grandfathering)

Where the financing arrangements in question were made before 4 March 2005, the relevant date for the application of PARA4A will depend on whether there has been a variation in the terms of the debtor relationship. Where the financing arrangements in question were made before 4 March 2005, and remained unchanged until 1 April 2007, the new rules do not apply until 1 April 2007.

Where the financing arrangements in question were made before 4 March 2005 and the arrangements were varied before 1 April 2007, then the new rules apply from the date of the variation.

Where an accounting period straddles the relevant date, the legislation applies to the part of that accounting period beginning with the relevant date treating it as if a new accounting period began on the relevant date.

Position for accounting periods starting before 4 March 2005

For earlier accounting periods, loans only fall within the transfer pricing rules where they are between persons, and one participates in the management, control or capital of the other, or another person participates in the management, control or capital of each of them - the basic rules of s147 TIOPA 2010.

A person includes a body of persons such as a partnership. So, for instance, where a partnership controls a company - as may often be the position in a private equity case - any loan from the partnership to the company is within the rules, even if none of the partners individually has a controlling interest. But where, for instance, the company is controlled by three partnerships, each of which has less than a 40% interest in the company then the rules will not apply since the control test - as extended to joint ventures - is not met.