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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: breaches of agreements between HMRC and the group: remedying a breach for future periods

INTM521020 explains the mechanism for dealing with the treaty implications of interest reclassified as non-arm’s length on thin cap grounds.

If the debt:EBITDA ratio for a particular year is higher than that agreed, a likely consequence is that not all the interest in that year will be deductible for tax purposes, but there is then the issue of what is appropriate in future years. If the situation is likely to repeat itself, the company may face further disallowances. Some renegotiation may be preferable, perhaps to amend the quantum of debt which is treated as interest-bearing, with the balance being treated as equity. Alternatively, it may be agreed that an additional amount of equity will be injected into the UK borrowing unit, to rebalance the ratio of debt to equity. It will depend whether the breach represents a pattern for the future, or just a fluctuation, and on what options the agreement offers.

In the face of a disallowance, the lender and companies in the borrower’s wider UK group may be able to claim compensating adjustments under TIOPA10/S182 and S192. See INTM413140 and INTM413160.

HMRC considers each year of a thin capitalisation agreement separately and on its own merit. It does not agree to any sort of averaging arrangement, spreading disallowances over several years to get the benefit of years with surplus borrowing capacity, any more than a third party lender would. Nor will it agree to an averaging of the effect of the covenants; each covenant is tested each year and the appropriate effect given to each.

TIOPA10/S220(2) means that the ATCA stands in the place of the legislation in dealing with the matters which the agreement covers by reason of S218(2). If the company wishes to renegotiate conditions going forward, it should indicate as much at the earliest opportunity.