INTM581010 - Thin capitalisation: practical guidance -comparison of lending in the UK with other countries

The conservative nature of UK lenders

Despite the fact that lending money is a competitive business, UK lenders have a reputation for being somewhat cautious and conservative.

Perhaps one way of looking at the degree of caution adopted by lenders is to examine the attitude of tax administrations in the formulation of their thin capitalisation rules. Such formulation is generally aligned with the acceptable financial ratios of the particular country. In the UK for example, with a few notable exceptions the debt:equity ratios of the companies in the Financial Times Stock Exchange (FTSE) 200 top companies are significantly less than 1:1, and whenever a major company exceeds what may be regarded as the norm it may come under shareholder pressure to reduce its debt. The UK does not have ‘safe harbours’ with regard to financial ratios that measure companies’ capitalisation, although in the past CT & VAT,International CT has given some indication of its attitude to financial ratios (see INTM579110), but some other countries do. The table below gives some examples.

Financial ratios adopted by various countries as thin capitalisation rules

CountryDebt:equity ratioComments
Australia3:1
  • Separate rules apply to financial institutions.
  • Interest in excess of the prescribed level is denied as a deduction. However, it is fully deductible if the company satisfies the arm’s length test.
Germany1.5:1 for trading companies.
  • Excess interest is non-deductible, being deemed a constructive dividend
  • Corporation tax will arise on a constructive dividend even if the recipient company has suffered a loss.
France1.5:1
  • Rules only apply to loans from parent, not from affiliates
  • There is no differentiation between types of companies.
  • From 2007 the deduction of interest paid to associated companies is subject to two limitations in respect of:
  • The overall indebtedness (Debt:equity ratio), and
  • The ratio between interest paid and the realised profits of the company (interest cover)
  • The deduction of excess interest in the above point can be carried forward, but will be reduced annually by 5% from the second year of the carry-forward period.
Japan3:1
  • There is generally no distinction between different types of company, but a corporation may elect to use a ‘reasonable’ debt:equity ratio instead of 3:1.
USA3:1
  • Statutory safe harbour provisions exist to determine if a thin capitalisation situation exists. However, a debt:equity ratio of 3:1 or less is usually acceptable, provided the taxpayer can service its debt without the help of related parties – cash flow and interest cover are considered.


The fact that UK lenders are conservative in nature is an important factor in considering whether a UK borrower is thinly capitalised. Of particular interest are two points that may be encountered in thin capitalisation negotiations:

third-party loans which are raised outside the UK and passed on to a UK subsidiary or affiliate on the same terms – see INTM581020 loans that are made on terms that differ substantially from the norm but which appear to be third-party – see INTM581030

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