INTM579060 - Thin capitalisation: lending against asset values: Offshore property companies

Looking into the financial structure of a property rental company is no different from any other thin cap case. Obtaining the facts is important and checking their reliability using normal investigative techniques is vital.

It is important to understand the nature of the company being dealt with: what properties does it own; when were they bought and how much did they cost; who is behind the company; what experience do they have of property?

Offshore Structures

As can be seen from the overview at INTM579030, a lot of UK commercial property is owned offshore, and where this is so it adds other risks which may need to be considered. It is often found that the person behind the company has UK connections and if this is so the offshore structures will need to be considered in that light. This is a specialised area and help can be sought from the non-resident specialists at Charity, Assets & Residence in Bootle.

Transfer pricing where there is an offshore structure is an everyday risk. Lending institutions will want the owners of a company to put in their own money and this will be typically between 15 and 25%. They do not usually mind whether that is done by share capital or by a loan. However, particularly if a loan can be sourced from a low tax jurisdiction, it is advantageous from the point of view of limiting the company’s liability to UK tax to use that debt rather than share capital. If the owner opts for a loan to provide their stake in the transactions, a prudent lender would seek to ensure that:

  • The owner’s loan is not secured on the property
  • The owner’s loan is repaid after the senior loan is repaid
  • The cash flow of the borrower is used firstly to service the senior debt, and only surplus cash flow after all other liabilities have been met diverted to service the owner’s loan.

Two of the major problems are discussed below:

  1. Loan To Value
The company may argue that although the senior lender would only lend say 80% of the value of the property, additional finance would have been obtainable through a junior or mezzanine loan and that the connected party loan should be on the same terms as those other loans. INTM579530 gives some advice on structured debt - senior, mezzanine, etc.
Whilst there is a market in providing additional finance, it is relatively small in relation to the market as a whole. De Montfort puts it at around 4% based on its surveys. CAR Residency’s experience of enquiry work on offshore companies suggests that third-party loans in these circumstances are very limited.
In cases of connected party funding, it is rare that evidence will be provided of the contemporaneous availability of a third-party loan. If material is put forward, it should to be tested in exactly the same way as any evidence provided in an enquiry. If the company has sought an offer of a third-party loan at the time, it must be established on what basis the provider was asked to quote, what the likelihood was of the loan ever being taken up, and why it was not. More often than not the evidence will have been provided long after the event, in response to HM Revenue & Customs enquiry. This is of low evidential value as it is only an opinion of what might hypothetically have been offered. It also begs the question as to whether the potential lender had any expectation that the company might take up their offer. What evidence is there that the company might ever have contemplated accepting a third-party offer? Such evidence might include Board minutes and notes of telephone conversations or email discussions with potential lenders.
  1. Margins
Even if the LTV is acceptable, the interest rate charged on a connected party loan may appear to be excessive. This may occur in connection with a high LTV but can be seen where it is within an acceptable range. Such a situation may occur where a loan from, say, a bank is less than one might expect. Here the company may argue that this was the maximum that the bank would lend but it may be that this was all the company requested because it wanted to top up the loan with a connected party loan at a much higher rate.
Many of the considerations mentioned in regard to LTVs also apply here. De Montfort can also be a help to demonstrate whether the senior loan is out of line with the market.
With both of these problems it can in some circumstances be worth doing a detailed cash flow exercise including amortisation because it can demonstrate the terms of a connected party loan make the loan uneconomic.

Other points to consider regarding offshore structures include the relevance of the Controlled Foreign Company (CFC) legislation where there is an overseas (subsidiary) group company controlled from the UK. If the overseas company is paying income tax rather than corporation tax in the UK, the CFC regulations may be in point and it may be appropriate to impute additional profits on the controlling (UK) company. Detailed technical discussion on this point is outside the scope of this module of the manual but advice will be available in the CFC material.

Similarly, where there is a UK individual behind the structure, ICTA88/S739 (transfer of assets abroad) may be relevant and it may be possible to attribute the income arising offshore to a UK individual. Again, detailed technical discussion on this point is outside the scope of this manual, but advice is available from CAR Residency.

UK property let out by offshore owners falls within the Non-Resident Landlords provisions. Generally income tax should be deducted from rental payments made unless the recipient is entitled to receive gross payments following registration with CAR Residency. Further information on the Non-Resident Landlords Scheme can be found at INTM370000.

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