INTM563020 - Thin capitalisation: FA2004 legislation - new rules on loan guarantees

Compensating adjustment for guarantors

As explained in INTM563010 it is necessary under the new ICTA88/SCH28AA/PARA1B to overlook the effect of a guarantee from a connected company when deciding whether to allow interest deductions to a company issuing a security.

However, ICTA88/SCH28AA/PARA6D provides for a compensating adjustment to be claimed by or on behalf of a loan guarantor in circumstances where a guarantee given by that company has increased the borrowing capacity of the borrower.

The compensating adjustment has to be claimed but the claim can be made by either the guarantor company or the borrower on behalf of that company. This does not entail a separate treaty claim.

The same time limits apply to compensating adjustment claims under paragraph 6D as for paragraph 1A adjustments (see INTM562040).

The effect of a valid claim under paragraph 6D is that the guarantor is treated as if it had taken out the loan and paid the interest on it and not the actual borrower. The guarantor is therefore allowed to have a deduction for interest that has been disallowed in arriving at the assessable profits or allowable losses of the actual borrower. The guarantor company must of course meet the usual conditions for a deduction. In particular, to qualify for an interest deduction, the guarantor must not be thinly capitalised, although in that case the guarantee is unlikely to have offered support for the loan.

All other tax consequences of the loan will also fall to the guarantor rather than the borrower in respect of the part of the loan secured by the guarantee. These may include exchange gains or losses and the obligation to deduct tax at source.

The provisions of the paragraph may apply in cases where there is more than one guarantor (see INTM563030).