INTM541050 - Introduction to thin capitalisation (legislation and principles)

Thinning out: example

The tax advantages of funding a UK group company by way of debt as opposed to equity have been set out in INTM541040.

These advantages have led to a phenomenon known as ‘thinning out’, whereby a UK group may be made thinner by the introduction of additional debt. This is demonstrated in the following example:

DRAWING - INTM541050D

The insertion of the new UK holding company in this example is purely tax–driven, as there is no commercial rationale for the insertion of this company.

The result is that the amount of UK corporation tax has been reduced in circumstances where there has been

• no real change in profitability
• no new capital introduced into the UK
• no enlargement of the balance sheet and income producing assets or investments

There are various ways to counter this abuse by applying the legislation at ICTA88/S209, ICTA88/SCH28AA,FA96/SCH9/PARA13 and F(No2)A05/S24-31 & SCH3. See INTM508000 on "thinning out" and the chapter on avoidance and arbitrage in the Intra-Group Funding module starting at INTM509000 for further details.