Having carried out a functional analysis of the UK group finance
company, the Inspector should be in a position to decide how the
company would be rewarded at arm’s length for the functions
it performs and the risks borne.
It is not possible to be prescriptive as to what an
arm’s length reward for a UK group finance company should be.
This depends on the precise nature and scale of the company’s
operations, which is why in a case of any magnitude a functional
analysis should be carried out as outlined on the preceding page.
If the functional analysis shows that the “treasury
company” is a mere conduit for funds, then the risk is lower
and a smaller amount of equity and lesser margin of reward may be
appropriate; if the company has more substance and incurs more risk
in its operations, a higher proportion of equity and greater reward
would apply.
The risks on the lending may be relatively low in a
particular scenario. Consider, for example, a situation where a UK
company is lending to a fellow group company which is trading in a
stable economic sector, has a history of low bad debts from its
customers and has a high fixed asset base. The UK company may have
managed to hedge any currency risks or interest rate exposures on
such lending (although this can be a complex and costly operation
in itself). In such a scenario the Inspector should accept that the
‘margin’ or ‘turn’ on the lending activity
should be lower than would be the case where the lending was
riskier (perhaps because of sector or credit risks which the UK
company would be unable to manage by hedging).
It is also important to stress that the margin or turn on a
company’s lending activity should be considered on a
loan-by-loan basis (except where it is sensible and proportionate
to consider classes or groups of loans together), and that reward
should reflect the circumstances of the making of each particular
loan, as would be the case if the group finance company were an
independent lender.
The reward for activities other than borrowing and lending
of money and associated risk management techniques should be
evaluated separately from that on the borrowing and lending
activities.
In a case where a UK group finance company has borrowed from
an overseas lender to fund its lending activities, the overseas
lender may make a treaty clearance application to receive interest
gross from the UK company. In these circumstances the Inspector may
wish to reach an agreement with the company as to what the position
will be on the gearing and profitability of the UK company for a
number of years going forward. This is permissible within the
context of a treaty clearance application. Any such agreement
should include a commitment by the company as to a maximum level of
gearing on its borrowing and lending activities and to a minimum
profit margin on those activities. The agreement should also
specify the consequences if the company should fail to comply with
any of the terms of the agreement, which will normally be by way of
restricting interest deductions and requiring additional equity to
be injected and/or debt to be repaid.
