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HMRC internal manual

International Manual

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HM Revenue & Customs
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Thin capitalisation: practical guidance: creating agreements between HMRC and the group: maximum amount of loan or facility

A thin capitalisation agreement may explicitly state the maximum amount of interest bearing debt which will be treated as being at arm’s length. This will not always be necessary, since other covenants may act as sufficient curb on excessive borrowing.

The maximum amount may be the actual amount of the loan or facility, or a lesser amount if the company could and would have borrowed less. It may be convenient to frame the condition in terms of the whole of the company’s interest bearing debt, rather than the particular loan or connected party lending. This will make the agreement more durable. An ATCA should in any case cover all interest-bearing debt.

Where the borrowing is in the form of a facility, and the company has not drawn the full amount agreed to be allowable, the maximum amount stated in the agreement may leave room for a certain amount of further borrowing if HMRC is satisfied as to purpose and borrowing capacity. On the other hand, a stricter approach would be preferable where an overall reduction in debt is one of the goals of the agreement, or where, as in private equity investment, the financing represents a package put together at acquisition.

An example of a flexible provision to cover later borrowing may take the form of a clause agreeing:

  • acquisitions up to a particular value in any one year without revisiting the agreement providing each acquisition is funded by an agreed proportion of debt and equity/cash
  • providing of course that the covenants in the agreement were not breached by the further borrowing
  • that larger amounts are notified and discussed HMRC.

Fees and charges

Where borrowings are drawn from a larger facility - possibly a global group facility - the (potential) borrower may be charged facility fees by the lender for holding a greater amount available for further drawdowns. These charges may not be genuine, since the group lender may not be incurring costs of holding the money available. Also, if a lower maximum amount of borrowing has been agreed by HMRC during thin capitalisation negotiations, even genuine charges relating to the amount deemed non-arm’s length will be disallowed along with the debt to which they relate.

Payments for genuine services must bear the correct transfer price, however, payments for “nothing” may be disallowed under CTA09/S54 as not being wholly and exclusively for the purposes of the borrower’s trade. See INTM522040 on interest rates and associated fees.

Details of the composition of thin capitalisation agreements are at INTM520010 onwards.