INTM508040 – Intra-group Funding: 'thinning out'

Commercial considerations

There may well be commercial reasons why, at arm’s length, a group’s debt to equity ratio might increase.

For example, where there is room for organic expansion and good prospects for future rewards, equity investors might want to take advantage of such opportunities by gearing up their investment and growing a successful existing business accordingly.

Alternatively a business might seek to grow by acquisition. And independent lenders will generally look quite favourably on applications for acquisition borrowings as long as

• the prospects are good

and

• there is a reasonably certain likelihood of early profit generation (such profits could be used to reduce debt levels or, on the assumption that the company retains a reasonable amount of the profit, could reduce gearing levels)
• there is the prospect of asset disposals generating cash which would then be available to reduce debt.

The example of 'thinning out' at INTM508020 is simplistic. In reality, 'gearing up' exercises are less obvious, as the 'thinning out' usually occurs opportunistically at the same time as a restructuring carried out for commercial reasons (global reorganisations, acquisitions or disposals, for example).

Inspectors should therefore look carefully at restructurings and reorganisations that have the effect of 'thinning out' and consider whether or not the commercial considerations justify the introduction of additional debt. In many cases, the normal commercial rationale present in third party acquisitions - economies of scale, synergies, etc – will be minimal or absent, because the newly acquired subsidiaries are already part of the same multinational group and so already benefit from the economies of scale, etc., without the necessity of reorganising the internal group ownership structure.