INTM582010 - Thin capitalisation: agreements between HM Revenue & Customs and the group: Introduction to the main features of the agreement

There is an example of a “model” agreement from INTM582100 onwards. This was issued alongside Statement of Practice (SP) 04/07 which set out the Advance Thin Capitalisation Agreement (“ATCA”) process.

At the conclusion of thin capitalisation enquiries or of the ATCA application process, a written agreement is (in most cases) put in place to provide an agreed method and set of parameters for calculating the arm’s length amount of interest for each year of the agreement. This agreement would in the past have also fulfilled the role of defining the conditions for treaty clearance for the loan or loans in relation to which the enquiry was undertaken, though this is no longer the case (see INTM572020).

An ATCA under FA99/S85-S87 and SP04/07 is drawn up without reference to CAR and is independent of any treaty clearance issues. However, the treaty clearance application remains obligatory wherever there is debt with a withholding tax requirement. This change in the process is explained in detail from INTM573010 onwards.

Where the discussions have taken place under the ATCA process, the borrower should at the outset have submitted at least outline proposals for an agreement, which by now should have been agreed, with or without amendments. Where the agreement is the result of a post-return enquiry or is linked to a treaty claim, the borrower should be asked to put together a draft agreement, based on the mutual understanding, which both sides can then fine tune and agree. It is preferable to ask the company or its representatives to draft the agreement, since they are best placed to set out the terms which they are seeking, and are more likely to have the resources to draft the document. It is at that stage only a draft, which even after the main discussions have concluded may be subject to last minute fine tuning and even quite serious differences as to the detailed terms.

To guard against future disputes about the terms of an agreement, it is important that it is carefully worded, unambiguous and contains a full and mutually-understood description of each point that has been agreed. The Model ATCA issued with SP04/07 provides a detailed example of an agreement, and this has been reproduced for convenience starting at INTM582100; it may be adopted and adapted with such modifications as are necessary at the conclusion of the enquiry or ATCA process.

Under normal circumstances, it would be expected that a thin capitalisation agreement between HM Revenue & Customs and the UK borrower would contain the following points:

• the maximum amount of the loan or loan facility (a debt cap) - INTM582020 
• the interest rate - INTM582030 
• specification of the duration of the agreement - INTM582040 
• the financial conditions to be fulfilled by the UK borrower - INTM582050 
• the treatment of interest paid if the conditions are fulfilled - INTM582050 
• the consequences of a breach of the agreement by the UK borrower - INTM582060 
• any particular conditions under which covenant breaches will be ignored - INTM582070 
• monitoring procedures - INTM582080 
• annual, or more frequent, notification procedures - INTM582090 

It is impossible to produce an exhaustive list or create a model agreement which allows for every eventuality, but these are the basic building blocks of a reliable agreement.

It may be necessary to include additional clauses for dealing with specific characteristics or issues, for example:

• a clause covering interest imputation where money is retained by the company for which it has no particular use but which the overseas parent or connected lender does not want to see repaid, perhaps to maintain a tax advantage or avoid an overseas tax charge;
• a declaration that an interest-free loan will remain on that basis for the duration of the agreement;
• a statement that a capital contribution will remain in place for the duration of the agreement;
• a clause specifying that where substantial amounts of cash are held, or are likely to be generated, at least a proportion will be applied to any subsequent investments, in preference to a wholly debt-funded acquisition. This might extend to a proportionate restriction on dividend payments, applying (for computational purposes) part of the proposed dividend to pay down part of the debt, to avoid the situation where all profits are paid up as dividends while acquisitions are debt-funded.
• An agreement as to where disallowances will fall, where more than one company is directly affected.

There is no reason why an entirely original clause should not be created, if it covers a problem or potential ambiguity to both parties’ satisfaction. The Transfer Pricing Team at Business International is happy to advise where the situation or proposal seems novel and there are doubts about the solution.

The chapter from INTM584000 onwards contains some information about third-party loan agreements that may be of use when setting up an agreement.