INTM578080 - Thin capitalisation: interest cover

The effect of amortisation

Amortisation of goodwill involves debiting to the profit & loss account over a period of years the amount paid for a business acquisition above the value of the tangible assets acquired. As such, it does not usually reflect a cash expense in the year in which it is debited, and it is sometimes contended that it should be added back in the calculation of interest cover. The HM Revenue & Customs response to this contention depends upon the business that has been acquired. If the reasonable projections for that business show that it is likely to be profitable in the immediate and foreseeable future, then the write-down of the original cost of goodwill should be counteracted by the additional future profits. In such circumstances HM Revenue & Customs will generally agree that amortisation can be added back, but it is dependent upon the facts of a particular case. In cases where EBITDA is used, it is normal to look for a higher ratio than when EBIT is used.

Before an Inspector will agree to the add-back of amortisation it will be necessary to demonstrate that the future profits of the acquired business will outweigh the costs – that there is a genuine reason to believe that the synergies of the acquisition are positive.