INTM579020 - Thin capitalisation: debt: equity ratio

What is debt?

A debt is much easier to recognise than to define but may be regarded as anything giving rise to the payment of interest or simulated interest (such as in a lease). See, however, INTM585350 for the treatment of interest cost with respect to pension schemes.

The UK legislation contains various definitions with regard to debt, although it should be noted that the legislation at ICTA88/S209 refers specifically to securities, so that ICTA88/S254 is important:

‘'security' includes securities not creating or evidencing a charge on assets, and interest paid by consideration given by a company on money advanced without the issue of a security for the advance, or other consideration given by a company for the use of money so advanced, shall be treated as if paid or given in respect of a security issued for the advance by the company.'

There is no doubt that the reference to a ‘provision’ in ICTA88/SCH28AA includes transactions involving debts.

In their agreements, third-party lenders may often define debt in a particular way. For example, in one third-party agreement seen by the CT & VAT, International CT (‘IntCT’) the term ‘borrowings’ was used, and was defined as:

  1. money borrowed or raised, including capitalised interest

  2. any liability under any bond, note, debenture, loan stock, redeemable preference share capital or other instrument or security

  3. any liability for acceptance, documentary credits or discounted instruments

  4. any liability for the acquisition cost of assets or services payable on deferred payment terms where the period of deferment is more than 90 days (except trading credit where the liability can reasonably be regarded as the subject of a bona fide dispute)

  5. any liability under debt purchase, factoring and similar agreements and capital amounts owed under financial leases, hire purchase or conditional sale arrangements

  6. any liability under any guarantee or indemnity (except product warranties)

  7. any liability under any foreign exchange or interest rate contract net of liabilities owed by the counterparty

Working a thin capitalisation case is not an exact science, and it is perhaps helpful to look at some examples that might be included in debt calculations rather than trying to find an all- embracing definition. A useful starting point might be a consideration of entries found in a set of UK accounts, since Schedule 4 of the Companies Act 1985 prescribes the balance sheet format for company accounts. The table below contains such examples, with comments.

Creditors accounts entryComment
Debenture loansA debenture clearly creates and acknowledges debt, and should be included in the consideration of debt.
Bank loans and overdraftsGenerally, these are interest-bearing debts and should be included. Revolving credit facilities are also included here.
Payments received on accountUnless significant interest is being paid on these, it may be appropriate to ignore them.
Trade creditorsUnless significant interest is being paid on these, it may be appropriate to ignore them.
Bills of exchange payableCompanies may use a bill of exchange as an alternative form of finance to bank borrowing. If they are interest-bearing, they should be included in the calculation.
Amounts owing to group undertakingsThese should be included in the calculation
Amounts owing to undertakings in which the company has a participating interestThese should be included in the calculation
Other creditors including taxation and social securityThere is no doubt that debts involving the Inland Revenue come within the loan relationship legislation and they are interest-bearing. However, they are not normally significant enough to be included.
Accruals and deferred incomeNot included in the calculation.


There are other items that may be implicitly included in the headings given in the table above but not explicitly named:

ItemComment
Interest-free loanAn interest-free loan may have characteristics of both debt and equity. For example, an interest-free loan that will last for a substantial number of years may be treated as equity. The question is whether such amounts form part of the permanent capital or not. They must not form part of the distributable reserves and agreed not to be repaid until immediately before equity. Such conditions may be written into the thin cap agreement.
Capital contributionSee INTM503050.
Finance leaseGenerally, the finance charge in finance leases is treated as if it were interest, and the accounts can be followed in their treatment. In cases of doubt it will be necessary to consult an HMRC accountant.


As a general rule, if it is likely that a third-party lender would take an item into account when considering the ability of the borrower to service the loan, it should be included in the calculation of debt. Payments in connection with shares are, however, excluded from such consideration.