INTM579060 - Thin capitalisation: debt: equity ratio
Dependence upon the commercial activity
As has been suggested in INTM579040, the arm’s length range of debt:equity ratios for a business is dependent upon the nature of the business itself. It is impossible to be prescriptive about what the range should be in any particular case, but the following may be of help when considering it.
- In the UK there is a tendency for third-party lenders to be cautious with regard to high debt:equity ratios, and for UK companies not to have high proportions of debt funding as compared with equity funding. For example, the majority of the companies comprising the Financial Times Stock Exchange 100 (FTSE 100) list have debt:equity ratios significantly less than 1:1.
- Financial institutions such as banks and insurance companies are regulated by the Financial Services Authority, which requires certain levels of equity and long term debt capital to protect depositors. The levels of capital, though based on international requirements laid down by the Bank of International Settlements (referred to as Basel ratios), are negotiated with each bank by the FSA. In practice UK banks will have more equity and often less long-term debt than is required by the FSA. For further information the following may be useful:
- The HM Revenue & Customs General Insurance Manual and Banking Manual both contain a more detailed discussion of the capital requirements of the respective types of institution.
- The HM Revenue & Customs Internet site contains guidance relating to the UK legislation at ICTA88/S11AA, effective from 1 January 2003, concerning UK branches of foreign companies.
- The Internet site of the British Bankers Association has information relating to banking practice: www.bba.org.uk.
- The Internet site of the Association of British Insurers has information relating to insurance practice: www.abi.org.uk.
- See also INTM504060 for further information on companies with treasury activities.
- As indicated in INTM579040, the debt:equity ratios of finance leasing companies are normally in excess of the average for other UK businesses. This does not include those whose business consists of operating leases, such as car hire companies. More information is available from the following sources:
- The Internet site for the Finance & Leasing Association: www.fla.org.uk.
- The HM Revenue & Customs Leasing Committee.
- A group of companies may have a mixture of commercial activities, each of which may have a different appropriate debt:equity ratio. This is discussed at INTM579090.
