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HMRC internal manual

International Manual

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Thin capitalisation: practical guidance: creating agreements between HMRC and the group: example of an agreement: model ATCA - appendix 2 - gearing ratio

HMRC has issued a model ATCA the body of which is at INTM520090. It is not intended for it to be followed slavishly, but it may serve as a template for many cases and as an aide memoire for the main features which HMRC is likely to expect to see in an agreement.

The model agreement’s second appendix is as follows:

Gearing Ratio

Period ending For example, Debt/EBITDA (or Equity or LTV)
   
20X1 b : 1
20X2 b : 1
20X3 b : 1
20X4 b : 1
20X5 b : 1

Calculation of Disallowance - Debt to EBITDA (or LTV)

The disallowance will be calculated by reference to the ratio shown above for the relevant period (‘the required ratio’) and the gearing ratio calculated using the actual results of the UK Group (‘the actual ratio’).

When using a debt to EBITDA (or LTV) ratio to measure gearing, allowable interest is derived from the following formula which calculates the amount of allowable debt:

required ratio (expressed as a number) x actual debt = allowable debt  
     
actual ratio (expressed as a number)    
     

Illustrative calculation for period ending 31 December 20X1 - Debt to EBITDA (or LTV)

Assume the agreement has a Debt to EBITDA covenant, and the actual figures for the period are debt of £d and an actual Debt to EBITDA ratio of a:1 which is greater than the required ratio (b:1). Allowable debt is therefore calculated as follows:

b x £d = allowable debt  
     
a    
     

This calculates the value of arm’s length debt from which allowable interest can be derived.

Calculation of Disallowance - Debt to Equity

When using a debt to equity ratio to measure gearing, allowable interest is derived from the following formula which calculates the amount of allowable debt:

[actual debt (£) + actual equity (£)] - actual debt (£) + actual equity (£)  
     
  1 + required ratio (expressed as a number)  
     

Illustrative calculation for period ending 31 December 20X1 - Debt to Equity

Assume the agreement has a debt to equity covenant, and the actual figures for the period are debt of £d and equity of £e and an actual debt to equity ratio of a:1 which is greater than the required ratio (b:1). Allowable debt is calculated as follows:

(£d + £e) - (£d + £e) = £n  
       
  (1 + b)