INTM578050 - Thin capitalisation: debt ratios - debt repayment: The UK borrowing unit
This is the largest grouping whose assets and liabilities are considered in assessing whether or not thin capitalisation is present.
Before 1 April 2004, the borrowing unit for thin cap purposes was defined at ICTA88/S209(8A) and consisted of the UK parent company and all 51% subsidiaries, wherever situated in the world. If there happened to be any singleton companies (or other, separate UK sub-groups) held directly from overseas but in the same worldwide group, then these would potentially constitute a borrowing unit in their own right, and could not be consolidated with any other UK grouping. In other words, if a US-owned group had three trading divisions, and for its UK operations it had three different UK parent companies, each heading up one of those divisions, then each of those UK sub-groups would have to be considered in isolation from each other, without consolidation or other way of set-off.
The position on or after 1st April 2004
The primary requirement of the legislation is that the borrowing company be considered without regard to any guarantees from connected companies, in effect on a “separate entity” or standalone basis. However, that is not the end of the story.
Even on a standalone basis, any third-party lender would take into consideration the assets and liabilities of the borrower’s subsidiaries, so in practice the post-2004 borrowing unit is (subject to the provisos below):
- borrower + 51% subsidiaries
If the borrower is a subsidiary within the UK group, the assets and liabilities of any company “above” it will be excluded, since to do otherwise would in effect be to recognise guarantees, and these are excluded by ICTA88/SCH28AA/PARA1B - see INTM562000.
Once it has been determined what constitutes the borrowing unit for a particular borrower, consolidated figures (not necessarily audited accounts, but accurate figures) will provide the necessary information for an assessment of the thin cap position. Even a bespoke consolidation for thin cap purposes can be an expensive and difficult exercise for a large multinational group, and it may be necessary to discuss the methodology and the extent of the exercise: what to do where the accounts of subsidiaries are produced using foreign accounting principles, where the business is organised by division rather than following a territorial corporate route, etc. For the company’s part, it must be able accurately to report the relevant figures for the borrowing unit in an agreed format at several points in time - while borrowing capacity is being verified, at any points agreed as part of the agreement, and as is necessary to demonstrate compliance with the agreement.
The compensating adjustments provisions at ICTA88/SCH28AA/PARA6C and 6D are more generous than under the repealed S209, because associated companies such as those in a parallel sub-group (as referred to above) will now have the opportunity to claim, assuming they are not also thinly capitalised. See INTM542180 onwards.
In cases where debt comes into different entities within a UK group, it may be sensible to relax the rule of insisting that every UK borrower (+ its subsidiaries) should be treated as a separate thin cap borrowing unit. If the group is self-contained and compact, it is possible to treat the topmost and largest borrower in the “cluster” as head of the borrowing unit and to regard subsidiary borrowers as assets and liabilities of the top company. This is the usual treatment for private equity cases, where money may come in at different levels within the group, forming part of a composite deal. This is a practical means of avoiding duplication of effort and unnecessary complexities, not an opportunity to expand the borrowing unit to increase borrowing capacity.
In practice, the position of overseas subsidiaries of the borrower may need closer examination. There may be restrictions on the repatriation of profits or income, or exchange difficulties, which mean that a third-party bank might be reluctant to accept the assets or income stream of that company as reliable security. Assets or income may simply not be accessible, or not reliably so. Equally, debt within overseas subsidiaries may distort the picture for the UK. For example:
- Debt may have been pushed down into subsidiaries in the course of a reorganisation, so interest liabilities arise in another jurisdiction where they might otherwise have been borne in the UK, yet with a simple consolidation, the UK borrower would gain no benefit for having done this. If a pushdown of debt is negotiated, there should be some recognition that liability has been moved out of the UK.
- Where overseas subsidiaries have borrowed directly from non-UK group members in such a way as creates no liability or obligation for the UK part of the group, there may therefore be an argument for excluding from the consolidation some part of the debt held overseas. This might occur where the company had agreed to “push debt down” into overseas subsidiaries and thereby reduced (in net terms, at least) its own debt burden. The borrower will need to make a strong case.
These situations are complex and fairly unusual, but exemplify the point that where overseas companies are involved, the solution may not be so simple as applying a standard formula.