INTM572010 - Thin capitalisation: an overview of thin cap work: Where the case begins

Where the case used to start

In the past, a thin capitalisation case often started at the Residency section of HMRC’s Charity Assets and Residence (“CAR”) (now the DT Treaty Team at LBS Nottingham), with an application from an overseas lender to receive interest from a UK borrower at the reduced rate of withholding tax permitted by relevant tax treaty (usually 0%). CAR would refer the request to the Corporation Tax office of the paying company, asking for advice on the clearance. This process applies to certified treaty claims received by CAR up to and including 21st March 2007. It is still an option where the lender actively chooses it, though this is an unlikely choice. What follows is now the standard process.

Where the case starts now

For clearance applications received by the Treaty Team in Nottingham after 21st March 2007, and for thin cap work unrelated to a treaty application, a new system is now in place, explained in detail:

• at http://www.hmrc.gov.uk/cnr/clearance-processes.htm,
• in Statement of Practice 4/2007,
• and with additional thoughts on certain aspects, in Revenue & Customs Brief 01/2009.

The treaty clearance process is now quite separate from any considerations of thin capitalisation or other financial issues. When an application is made, the Nottingham team will consider and possibly enquire further into treaty-related issues, and tell the CT office when clearance has been granted. For the CT office, this is information for possible future use - perhaps providing advance notice of a major acquisition - not an opportunity to take up thin cap enquiries. As mentioned above, it is still possible for companies to opt for the “old” process - to link treaty and thin cap clearance, but, as noted above, this is unlikely to happen.

There are now two avenues by which thin cap and associated issues can be explored:

• Taxpayer-initiated: An application from the borrower for an Advance Thin Capitalisation Agreement (ATCA), under the APA legislation at FA1999/S85 -S87. This is the equivalent of the previously informal request for a forward agreement, which was received from companies wishing for some certainty regarding future interest deductions (INTM573000 onwards)
• HMRC-initiated: A post-return enquiry - i.e. questions raised on thin cap grounds following receipt and risk assessment of the latest CT return. This will only happen if the business case for the enquiry is agreed by the Transfer Pricing Panel under the Transfer Pricing Governance rules (INTM453040)

HMRC can no longer initiate a thin cap examination of a company’s funding until it is in a position to commence a post-return enquiry. Limited discussion may take place pre-return, where a company wishes, to explore the issue of applying for an ATCA or otherwise agrees to discuss issues in real time, but future certainty can only be obtained through an ATCA.

Advance Thin Capitalisation Agreements (“ATCAs”)

Statement of Practice 04/07 sets out in detail how the ATCA process works. The onus is on the applicant (the lender) to provide a detailed package of information plus proposals for the terms of an agreement for HMRC to consider. There is a Model ATCA available at http://www.hmrc.gov.uk/cnr/draft-atca-v1.pdf which can form the basis of the individual agreement. This model has also been included in this Manual, starting at INTM582100.

An ATCA application is made under the Advance Pricing Agreement legislation at FA99/S85-87 and is not subject to the Transfer Pricing Group governance rules (INTM573010). Revenue and Customs Brief 01/09 explains what happens where an ATCA and a post-return enquiry overlap.

It should be clearly recognised that the effective separation of the “treaty” stage from the “thin cap” stage does not in any way affect any obligation upon the lender to apply for clearance under the relevant double taxation agreement to receive interest at the treaty rate. As happened before with CAR, the treaty application must be sent to LBS Nottingham, who will have the same responsibilities as when CAR handled the claims.

The ATCA process has expanded the scope for thin cap agreements, allowing for agreements to be reached in circumstances where there is no treaty clearance issue: for example where funding is by quoted Eurobond for which there is no withholding tax obligation, or where the debt is issued at a discount and repaid in a higher figure, with no interest payments requiring a treaty claim.

Post-return enquiry

An enquiry into thin cap issues constitutes a transfer pricing enquiry within the governance rules of the Transfer Pricing Group, and will require approval of a business case for taking up the enquiry, regular reviews, etc. (See transfer pricing governance rules from INTM453000)