INTM563050 - Thin capitalisation: FA2004 legislation - new rules on loan guarantees

The effect of the compensating adjustment rule for loan guarantors

ICTA88/SCH28AA/PARA1A contains nothing equivalent to the concept of a UK grouping as set out in ICTA88\S209(8C) to 8(F) (see INTM547020). Under the new legislation debt capacity is to be measured solely by reference to the assets and income of the borrowing company. However, in practice the effect of paragraphs 1B and 6D, which deal with loan guarantees, will be largely to replicate the UK grouping rules, as the following example will demonstrate:

In this example, A is a non-resident company and B, C and D are all resident in the UK. For periods up to 31 March 2004, the old UK grouping rules allow support for D’s borrowing to be taken into account if it comes from B or C, but not if it comes from A, which falls outside the UK grouping as defined.

For periods from 1 April 2004 paragraph 1A(4) means that, when applying the provisions of ICTA88/SCH28AA to the intra-group loan received by D, no account can be taken of support for D’s debt capacity provided by A, B or C. This is reinforced by paragraph 1B(4) which requires such support to be disregarded even if the loan had been received from a third party lender.

However, the scope of paragraph 1B is not restricted to third party loans, and where it has effect, as explained in INTM563020, it gives rise to a compensating adjustment under paragraph 6D which allows the guarantor to be treated as if it had paid any interest disallowed under ICTA88/SCH28AA/PARA1B. The terms of paragraph 1B are widely drawn, with a comprehensive definition of “guarantee” in paragraph 1A(7).

This means that, in the above example, if D’s assets and income are insufficient to demonstrate that it would have borrowed the full amount of the intra-group loan from an independent lender, but if a guarantee given by either B or C would justify the full amount of the loan, then a compensating adjustment given under paragraph 6D may be claimed by either B or C (or some combination of the two) to the extent that interest was disallowed as a deduction for D.

In practice, where there is an intra-group loan, it may generally be assumed that a guarantee as defined in paragraph 1B(7) is in place, even in the absence of a formal, written guarantee. This means that compensating adjustments for loan guarantors will be available whenever another company in the same UK sub-group has sufficient debt capacity to support an intra- group loan.