Thin capitalisation: practical guidance: accountancy issues: introduction: accountancy impact on thin capitalisation
Thin capitalisation is a particular type of transfer pricing and seeks to ensure that debts are provided on an arm’s length basis. Financial information is used by HMRC to consider the arm’s length value of debt, for instance by looking at cash flow forecasts and negotiating debt covenants.
There are a number of financial ratios used to monitor thin capitalisation compliance, including interest cover and debt-linked ratios. The financial information used to compute these ratios is usually an entity’s statutory accounts.
The advent of International Financial Reporting Standards (“IFRS”) in 2005, revisions to International Accounting Standard 19 (IAS 19) and the introduction of New UK GAAP have resulted in a range of potentially applicable accounting standards. Further background detail is provided in INTM523150.
Interpretation of accounting standards affects thin cap-related issues; for example, whether entities have the cash flows and borrowing capacity to properly service the debt in question. It seems somewhat skewed towards discussion of FRS 17, since that is how it originated, but over time this should rebalance.
If support is required please consult a transfer pricing specialist, a member of Business International or a compliance accountant.