INTM578100 - Thin capitalisation: debt ratios - debt repayment: Groups with mixed activities

The group considered here is the “borrowing unit” which for ICTA88/SCH28AA purposes is the borrower + 51% subsidiaries (subject to the provisos considered at INTM578050).

In order to arrive at the arm’s length amount that could be loaned to the borrower it is necessary to work out debt and interest cover ratios which are appropriate for the whole of the grouping headed by the borrower. However, the mixed nature of some groups means that a general value does not sufficiently take account of the borrowing ability or needs of the individual parts of the group. This may not be a problem unless unusually high levels of debt are contemplated, in which case it would be appropriate to ask what a third-party lender would be likely to do. The answer is that it would look at the borrowing capacities and needs of the individual components of the borrowing unit, add them together to get an overall capacity, and then consider how the fact that there is a group, rather than separate entities, affects the overall result. Among the factors that it would take into account are the following;

• There is an insurance sub-group. In general, UK insurance groups do not have a high debt:equity ratio - the ratio is typically significantly less than 1:1. However, an insurance-broking company, while it may be regulated as to its activities, will not be regulated in the same way as an insurance company with regard to its capital. Its borrowing capacity will have to be looked at separately, and in the light of the fact that insurance brokers do not generally borrow highly because the nature of the balance sheet assets mean that the net worth of the company is all that is available to support debt. It is advisable to consult financial sector specialists when looking at insurance and other regulated businesses.
• There is a finance leasing sub-group. Typically, such groups may have high debt:equity ratios. However, a third-party lender may wish to ensure that any part of a loan made on the basis of such a ratio genuinely goes to the leasing group and not to other parts of the grouping, and so may specify as much explicitly in the agreement.
• A trading sub-group resident in France. It may be appropriate to look at the borrowing capacity of this sub-group in France, to see if it would be able to obtain terms that are more favourable than in the UK.
• There is a manufacturing sub-group. If there is nothing special about it, such as starting up or rapid expansion, then a “steady state” treatment may be appropriate.
• There is a company with a treasury function. See INTM504060.

Any of these may be carved out and a separate agreement made, if they have a distorting effect which cannot be accommodated by adjustments to a single agreement. Alternatively, it may be possible to agree a methodology for arriving at a “blended ratio” for each covenant, a single ratio reflecting the various group components. A blended ratio may be dragged down (or dragged up) by particular components, so that the blend may fail where one or more separate agreements might have succeeded, or it may succeed where one or more of the separates would have failed.