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HMRC internal manual

Tonnage Tax Manual

HM Revenue & Customs
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The ring fence: Interaction of finance costs and transfer pricing

State aid considerations

Tonnage tax is a State aid (broadly a benefit out of public resource to a particular sector which could potentially distort competition).  It is, however, one notified to and approved by the EU Commission.  See TTM01250.

Among the conditions stipulated in the approval are

  • that open market values are used for tax purposes where transactions within a group take place across the ring fence
  • that no tax relief for the costs of debt finance relating to qualifying activities within the ring fence are available outside.

These conditions underpin the existence of transfer pricing arm’s length principles (TTM7300 onwards) and the finance cost adjustment (TTM7400 onwards).

Interest-free loans

Where there are any intra-group interest-free loans across the tonnage tax ring fence, the transfer pricing rules should be applied before the finance cost adjustment rules are applied to the group.   Where the borrowing company is inside the ring fence, no deduction for the imputed interest payable (notional finance cost) will be available.  The finance cost adjustment rules will then apply to restrict to activities taking place outside ring fence the group’s allowable finance costs by reference to a just and reasonable proportion.

Interest-free loans used as an alternative to equity investment

Many shipping groups use intra-group interest-free loans from one UK company to another as a more flexible alternative to an equity investment.  Under the transfer pricing rules, interest is not imputed on loans which cross the ring fence if they are properly regarded as performing an equity function – i.e. where, and to the extent that, the loan renders the debtor company thinly capitalised.

The fact that an interest-free loan is made as an alternative to an equity investment does not in itself mean that the loan is performing an equity function.  The transfer pricing rules will operate to impute interest on loans where they cross the ring fence unless they do perform an equity function.  There is guidance at INTM502010 onwards.  If the loan or any part of the loan is actually performing an equity function (i.e. the debtor is thinly capitalised), then interest will not be imputed, or will be imputed only on the balance of the loan which does not serve an equity function.


Outline of transfer pricing TTM07300
Transfer pricing between companies TTM07310
Outline of finance costs adjustment TTM07400
Meaning of ‘finance costs’ TTM07410
Group companies’ finance costs TTM07430
Intragroup interest-free loans: Examples TTM07510