INTM578030 - Thin capitalisation: debt ratios - debt repayment: What is equity?
For thin cap purposes, the equity of a company includes issued share capital, the retained profits of the company, well-substantiated reserves, and other items representing genuine value in the company. However, there may be shares which have the characteristics of debt and should be treated as such.
As with the consideration of debt in INTM578020, it is useful to look at the description of “Capital and reserves” at Schedule 1 of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 regarding balance sheet format when considering what constitutes equity.
Capital & reserves accounts item |
Comment |
Called-up share capital |
Included as equity. |
Share premium account |
Included as equity. |
Revaluation reserve |
This would normally form part of ‘shareholders’ funds’. However, a third-party lender would want to be satisfied that the revaluation had substance and was realistic, and they would want evidence of that. For example, a recent valuation of company property by a qualified, independent valuer would suffice. Unless there is reason to believe otherwise, audited accounts in which revaluations occur can be accepted. However, if the revaluation amount is below the minimum level considered by auditors but it has a significant bearing on a thin capitalisation position, it should be reviewed. |
Capital redemption reserve |
Included as equity. |
Other reserves (in particular, goodwill) |
See ‘revaluation reserve’ above, and treat with caution, particularly where goodwill is concerned. HM Revenue & Customs takes the view that goodwill is recognised sufficiently in the projections of future profits which a company will submit, and “goodwill reserves” should not count as equity. |
Retained profits |
The accumulated profits and/or losses of the company are part of the equity of a business, and form an entry in shareholders’ funds. Where the company has sustained losses, this may be a negative balance which reduces the overall amount of equity |
See also ‘capital contributions’ at INTM503050 and ‘interest-free loans’ at INTM578020. For both these items, it is advisable to record an understanding in the thin cap agreement that they remain in place and on the same terms as confirmed with HMRC. If these formed part of the basis of the initial calculation of the debt:equity balance, or were even simply excluded from debt for the purposes of the agreement, it is helpful to retain them in place to help avoid compromising that measure.
