Guarantees, whether explicit or implicit, may be subject to
transfer-pricing adjustments, since they constitute a business
facility and/or a provision extended to another party, and one
which should carry an arm's length price. A guarantee fee is a
provision that would be charged for at arm's length. It represents
the use of another party's credit rating, which can be a very
valuable commodity. The problem is that a guarantee may be given
across a range of circumstances: it may be an additional formality
which does not materially affect the cost of borrowing, or it may
be that the loan would not have been made at all without the
guarantee.
If a UK parent gives a guarantee to facilitate the third
party borrowing of its affiliate, should a guarantee fee be imputed
to the UK company?
Implicit
If the guarantee is only implicit, the lender would not be able to sue the UK guarantor company if the borrower were to default on the loan. The UK would have taken no risk. Even a comfort letter from the UK parent may not be sufficient unless it legally binds the issuer in the event of default. It might be argued from HM Revenue & Customs’s point of view that the affiliate has received the loan by relying on the good name, credit rating, etc of the UK company and therefore the latter should be rewarded. A counter argument would be that it is only an incidental benefit to the affiliate of being a part of the group, that the UK is offering nothing that is not already in place, namely its reputation and strength, and that those are qualities of the whole group, in the UK and abroad. To succeed with that argument, the group would need to demonstrate that the parent company has not in any way affected the cost of borrowing for the subsidiary.
Imputation in these circumstances is unlikely, a tentative conclusion supported by the OECD Transfer-Pricing Guidelines (at Para 7.13). This gives an example which distinguishes 'passive association' from 'active promotion'. It states that 'no service would be received where an associated enterprise by reason of its affiliation alone has a credit-rating higher than it would if it were unaffiliated, but an intra-group service would usually exist where the higher credit rating were due to a guarantee by another group member'
If there is an explicit guarantee then, under OECD guidelines, interest can be imputed.
The size of the guarantee fee depends on the value of that guarantee to the borrowing party. This is often calculated as a percentage of the principal concerned - perhaps 1% or 2%, though it may be higher. It is advisable to calculate roughly the possible yield which could be achieved by imputing a fee before becoming too embroiled in a case.
Where the guarantee has reduced the cost of borrowing, HM Revenue & Customs may seek to impute a return for the guarantee. If the debt stands in the place of equity, then, on a concessional basis, it may be that interest will not be imputed.
One way of tackling this would be to obtain the credit ratings
of the borrowing and lending companies involved (either from the
companies themselves or perhaps from the Internet), and then look
for the differential of the interest rates available to them. The
UK 'home group' is likely to be more substantial and credit-worthy
than an overseas affiliate, and will be a lower risk for a bank,
and rates of lending would reflect that. However, data on an
overseas affiliate may be difficult to obtain, and it will be
necessary to invite the taxpayer’s cooperation in
establishing what the cost of borrowing would have been without the
guarantee. If the UK group secures a lower rate for an overseas
company, a proportion of the difference between what the latter
would have paid as an independent and the better rate secured for
it by the guarantee might form a basis for arriving at the rate of
return to the UK i.e. a reasonable share of the benefit obtained by
the overseas borrower through the influence of the UK guarantor.
The degree of risk present for the guarantor is another
consideration.
For the treatment of guarantees under ICTA1988 SCH28AA as
amended by FA 2004 - see
INTM563050.
