INTM580040 - Thin capitalisation: private equity: Applying the transfer pricing rules - “acting together”
Position for accounting periods starting on or after 4 March 2005
The provisions of ICTA88/SCH28AA/PARA4A apply the transfer pricing rules where persons have “acted together” in relation to the financing arrangements of a company or partnership.
“Acting together” has a very wide meaning and it is not necessary for a loan provider to have an equity interest in the borrower for it to be within the scope of the legislation.
In the context of a leveraged buyout, all of the finance providers involved in the transaction may be within the scope of Schedule 28AA so each of the loans would need to be considered to see whether they are on arm’s length terms. However, where the loan is from a senior or mezzanine lender who is otherwise unconnected with the equity investors, the risk that it produces other than an arm’s length result is likely to be low.
INTM461260 contains more guidance on risk assessment where persons have “acted together”, describing circumstances that might give rise to a risk, where the result may be other than arm’s length.
In practice, the more significant risk that the lending may be on other than arm’s length terms will be with the shareholder debt. However, there will be circumstances where non-shareholder debt may also need to be considered critically; for instance, where the buyout is part financed by loans from the vendor, or any loan that is, in substance, an equity investment. If the lending occurs as part of a deal in which the lender acquires or disposes of their shares, the implications of the co-ordination/linkage of the lending and the share transaction should be considered.
Another scenario which will require careful consideration is where the borrower is in a distressed situation and subject to a financial restructuring whereby a lender who previously had no stake in the equity of a business becomes an equity investor or an existing equity investor increases their stake as part of the restructuring. Then there is a risk that the refinancing by the lender is influenced by their stake in the business to the extent that the lending is not an arm’s length provision.
Transitional rules for pre-4 March 2005 financing arrangements (grandfathering)
Where the financing arrangements in question were made before 4 March 2005 the relevant date for the application of PARA4A will depend on whether there has been a variation in the terms of the debtor relationship. Where the financing arrangements in question were made before 4 March 2005 and remained unchanged until 1 April 2007, the new rules do not apply until 1 April 2007.
Where the financing arrangements in question were made before 4 March 2005 and the arrangements were varied before 1 April 2007 then the new rules apply from the date of the variation.
Where an accounting period straddles the relevant date, the legislation applies to the part of that accounting period beginning with the relevant date treating it as if a new accounting period began on the relevant date.
Position for accounting periods starting before 4 March 2005
For earlier accounting periods, loans only fall within the transfer pricing rules where they are between persons, and one participates in the management, control or capital of the other, or another person participates in the management, control or capital of each of them- see INTM432060.
For these purposes, a person includes a body of persons such as a partnership. So, for instance, where a partnership controls a company - as may often be the position in a private equity case - any loan from the partnership to the company is within the rules, even if none of the partners individually has a controlling interest. But where, for instance, the company is controlled by three partnerships, each of which has less than a 40% interest in the company then the rules will not apply since the control test - as extended to joint ventures - is not met.