INTM575020 - Thin capitalisation: working a case - the earliest stages: Risk assessment 1 - the basics

Thorough risk assessment of a case is an important part of a potential thin capitalisation case - see INTM572040. This page gives some thoughts on the subject, but does not replace Local Compliance/LBS risk assessment programmes.

If the case presents itself in the form of an application for an Advance Thin Capitalisation Agreement (“ATCA”), there is only limited discretion about whether it should be accepted for consideration: grounds for rejection might include:

• financing arrangements which do not appear to be significant commercial issues for the company, or
• proposals which are subject to variations, suggesting that at least one purpose of the exercise is to fine tune tax planning. (Revenue & Customs Brief 01/09 confirms HM Revenue & Customs’ view on this latter point)

Background information

• Papers on previous thin cap enquiries (including some worked by earlier incarnations of Business International), and even a current or recently-expired thin cap agreement.
• Domestic and overseas returns for other companies in the group, including those of group members holding or transacting with the company under review. (See INTM575010 on internet sources)
• Group websites (source of “glossy” accounts, news, history, etc), databases such as FAME, sources of returns and wider company/group information such as OneSource. All these may give indications about the function and relative importance of the company within the global group, the purpose and importance of the company, its place within its industry and how it is financed.
• Websites and databases can provide information about the group’s presence in tax havens (low or no tax) and tax shelters (tax breaks for particular businesses). These tend not to have full double taxation agreements with the UK, so finance sourced from such a territory may be routed via an intermediate territory. The Netherlands and Luxembourg are favoured choices. The same may be said where finance originates in a territory like Canada or Belgium where for direct investment into the UK there will still be a residual rate of withholding tax even after clearance has been given under the bilateral treaty, often 10%. There is every incentive to use indirect routes.
• Public information and commentary on the internet with regard to major mergers and acquisitions. There is a great deal of commentary from industry watchers, discussion of the means by which the groups are unified, pre- and post- takeover strategies. Entering the names of the two (or more) groups as search terms is usually enough.

Do the transfer pricing rules even apply?

The exemption for small and medium-sized enterprises (SMEs) is discussed in more detail in the transfer pricing guidance at INTM432112. It is expressed in terms of number of employees, turnover and balance sheet value. The current definition came into force on 1st January 2005.

There is also an important additional condition for SME exemption, that the same data will be added together for all linked enterprises in making the calculation, which means that group companies will be aggregated, and small companies of a significant group are unlikely to qualify for exemption.

Points never to lose sight of

The following have long been the initial points of entry in evaluating submissions to Business International requesting formal action such as directions:

• What are the transactions?
• Who are the parties to the transactions?
• Is there the necessary control relationship between them?
• How much tax is at stake?
• Which legislation applies?

At the risk assessment stage, the answers to some or all of these questions may be uncertain, and some may need revisiting and revising as the enquiry progresses, but it should be possible to make a reasonable estimation or an educated guess as to whether the case might fail on some fundamental level. This checklist should be borne in mind and revisited as information is fleshed out.