INTM578090 - Thin capitalisation: interest cover
The effect of unexpected items
While companies will have business plans and projections, it is
impossible to foresee every eventuality. The question may therefore
arise as to the extent to which allowance should be made in the
calculation of interest cover for an unexpected situation. The
first point to be made, of course, is that one always starts with
the audited profit & loss account.
It is impossible to write down here a list of all
eventualities and the HM Revenue & Customs response to them. We
attempt only to give a few guiding principles.
Downturns in business conditions
Normal downturns in business conditions are part of the risk of
the business itself. Some businesses are cyclical in nature, so
that the levels of profitability are unpredictable over a given
time. A third-party lender would expect to take this into account,
and so does HM Revenue & Customs in its thin capitalisation
work. Thus thin capitalisation agreements (see
INTM582000 onwards and
INTM583000 onwards) will generally
follow third-party agreements in being conservative about lending
where there is a perceived variability of profits.
Even where there is no cyclical pattern of business,
downturns do occur. It is therefore important to take into account
the commercial direction of the business being considered. This
should, of course, be reflected in the business projections, but a
general awareness of the business outlook will also help.
Generally, the expenses of normal business, including those
attributed to downturns, would be regarded by a third-party lender
as something to be taken into account, and HM Revenue & Customs
will do the same. For example, redundancy costs resulting from a
contraction of the business would be regarded as a normal expense.
Where there is a breach of a thin capitalisation agreement because
of normal downturns in business, HM Revenue & Customs will not
normally agree to ignore it.
Catastrophes
By its very nature a catastrophe is not normally predictable, and it may have a profound effect upon the profit & loss account, with the result that it is not possible to allow for it specifically in the interest cover calculation. Normally, a third-party lender might be expected to be sympathetic to a catastrophic incident if it were clear that it would not affect the ability to service debt too far into the future. For example, a rail disaster that affected a business’s ability to trade for several months and therefore affected its profit & loss account might be so viewed. INTM582040 contains more details on how these considerations might be factored into a thin capitalisation agreement. This does not mean, however, that so-called exceptional items in accounts will automatically be disregarded. It is necessary to consider each one on its merits.
