Thin capitalisation: practical guidance: creating agreements between HMRC and the group: introduction to the main features of the agreement
How an Advance Thin Capitalisation Agreement (“ATCA”) should look
An example of a “model” ATCA is at INTM520100. This was issued alongside Statement of Practice (SP) 01/12 (INTM520085) which sets out the ATCA process.
At the conclusion of thin capitalisation enquiries or of the ATCA application process, a written agreement is (in most cases) put in place to provide an agreed method and set of parameters for calculating the arm’s length amount of interest for each year of the agreement, for up to five years into the future.
An ATCA is made under the advance pricing agreement legislation in Part V of TIOPA10, and is no longer linked to the treaty clearance process.
Where the discussions have followed the recommended ATCA process, the borrower should have submitted firm proposals for an agreement at the outset, as required by TIOPA10/S223. Once the content of the ATCA is agreed, the borrower should be asked to put together a draft agreement on that basis (or amend their draft accordingly). The company or its representatives are best placed to draft the agreement, since they are seeking the agreement and will need to be comfortable with the commitments they are making. Both sides can then fine tune and agree terms. It is at that stage only a draft, and there may in some cases be quite serious differences as to the detailed terms, but this should not turn into a prolonged round of tweaking for either party.
To guard against future disputes about the terms of an agreement, it is important that it is carefully worded, unambiguous and contains a full and mutually understood description of each point that has been agreed. The Model ATCA issued with SP01/12 is reproduced for convenience at INTM520100, and may be adopted and adapted with such modifications as are necessary.
A standard agreement will normally address the following points:
- the maximum amount of the loan or loan facility (a cap on the debt) - INTM520020
- the interest rate - INTM520030
- start and end date for the duration of the agreement - INTM520040
- the financial conditions to be fulfilled by the UK borrower - INTM520050
- the tax treatment of interest paid if the conditions are fulfilled - INTM520050
- the consequences of a breach of the agreement by the UK borrower - INTM520060
- any particular conditions under which covenant breaches will be ignored or modified - INTM520070
- monitoring procedures - INTM520080
- annual, or more frequent, notification requirements - INTM520090
It is impossible to produce an exhaustive list or create a model agreement which allows for every eventuality, but these are the basic features of a comprehensive agreement.
It may be necessary to include additional clauses for dealing with specific characteristics or issues, such as:
- a clause covering transfer pricing treatment of money held by the company (see INTM501000 on interest imputation). Cash may be retained by a UK company because the overseas parent or connected lender does not want it repaid - perhaps for UK or overseas tax reasons. Furthermore, such money may not earn an arm’s length reward if it is on-lent within the group. A loan which has outlived its purpose may be vulnerable to challenge under CTA09/S441 (FA1996/SCH9/PARA13).
- a declaration that an interest-free loan will remain so for the duration of the agreement.
- a statement that any capital contributions or interest free loans will remain in place for the duration of the agreement.
- a clause specifying the proportions of debt and cash/equity which will be applied to future acquisitions, where discussions suggest that this is a low risk and practical provision. This would only apply to a modest level of expenditure, and a cap on its application would be advisable. This might be helpful where a cash generative business was intending to make acquisitions.
- a clause to restrict dividend payments in order to avoid the situation where all profits are paid up as dividends while acquisitions are debt funded.
- a clause which details where disallowances will fall where more than one company or source of funding is affected.
Some of the above will be fairly routine; others more unusual. This list cannot cover every eventuality, and it may be necessary to agree additional clauses in order to address specific issues. The Transfer Pricing Team at CSTD Business, Assets & International is happy to advise.
The chapter from INTM522000 onwards contains information about third party loan agreements that may helpful when setting up an agreement.