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HMRC internal manual

International Manual

HM Revenue & Customs
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Arbitrage: legislation and principles - deductions: interaction with thin capitalisation agreements

Interaction with thin capitalisation agreements

HM Revenue & Customs does not intend to re-open negotiations for most existing thin cap agreements. However, in reaching thin cap agreements, consideration was given to the amount that the borrower would have borrowed at arm’s length. In the absence of the anti-arbitrage legislation, there could not be any consideration of whether debt was incurred as part of a scheme having a purpose of achieving a UK tax advantage through arbitrage.

Therefore there will be some cases where, despite the existence of a thin cap agreement, interest will be disallowed under the arbitrage legislation. However, this will generally be the case only where the arbitrage legislation applies, as set out in the guidance, and is likely to be limited to circumstances where:

  • A loan has replaced part of the borrower’s equity within the terms of the thin cap agreement (see INTM595075 the 5th paragraph of the Inward Investment example);
  • the arm’s length interest rate is increased due to the use of a hybrid instrument or entity; or
  • the debt lacks a clear commercial purpose.