INTM582020 - Thin capitalisation: agreements between HM Revenue & Customs and the group: Maximum amount of loan or facility
A thin capitalisation agreement may explicitly state the maximum amount which can be borrowed under the agreement, particularly since with the separation of the treaty clearance process from thin capitalisation considerations, further borrowings once the agreement has been concluded are less likely to be come to the attention of the CT office than was previously the case. This will not always be appropriate, since other covenants may act as sufficient curb on excessive borrowing.
The maximum amount may be the actual amount of the loan or the maximum amount of the loan facility made available, or it may be a lesser amount. With the lack of notice on new borrowing, as mentioned above, the maximum might be better framed in general terms of interest-bearing debt, rather than a particular loan or connected party lending. This will make the agreement more robust.
There are potential difficulties where the maximum amount of a loan facility is specified and that amount is not fully drawn immediately. If further borrowings are likely, their purpose should be discussed. If borrowings are likely to increase and fluctuate, the agreement should aim to build in a certain amount of headroom, so that there is some room for manoeuvre before the borrower hits the limits of its covenants. The agreement should as far as possible be able to accommodate further borrowings without reopening the issue, unless an overall reduction in debt is one of the goals of the agreement.
A thin capitalisation agreement for an amount lower than the facility maximum may be the answer (a “capped” facility). It should also be made clear that clearance under the thin capitalisation rules does not extend to clearance under any other legislation. This would be going beyond the scope of the advance pricing agreement legislation at FA99/S85(2). The 2005 anti-avoidance legislation against exploitation of tax arbitrage, for example, has its own clearance process, administered by specialists from the Transfer Pricing Team at Business International.
It may be reasonable to include a provision for further borrowing to take place covering, say, acquisitions up to an agreed amount each year, without triggering a reopening of the case (providing the covenants in the agreement were not breached by the further borrowing). Such a provision might include an understanding that the borrowing would be matched by cash investment from another source, such as retained profits or equity injection. A cap should be set on the value of acquisitions which can be made each year under the arrangement, so that exceeding the agreed total annual value would trigger further discussion with HM Revenue & Customs, while any associated breaches of debt or interest covenants would trigger disallowances. Larger acquisitions might trigger a review without necessarily jeopardising the agreement.
Another aspect to consider is where borrowings are drawn from a larger facility - possibly a global group facility - and the (potential) borrower is charged facility fees by the lender or the principal borrower (the global parent, usually) for holding a greater amount available for further drawdowns. These charges may not be genuine, since the group lender may not incur such costs; it is not really holding the money available. Also, if a lower maximum amount of borrowing has been agreed by HMRC during thin capitalisation negotiations, even genuine charges may become recharacterised as non-arm’s length because they relate at least in part to debt which has been agreed to be excessive and therefore capped in a lower figure.
Fees and charges may be handled in different ways. Payments for genuine services must bear the correct transfer price; payments for “nothing” may be disallowed under ICTA88/S74 as not being wholly and exclusively for the purposes of the trade of the borrower. There is evidence that banks are treating items like arrangement fees very much as part of the means by which profits are made from the transaction, so such costs could be added to the total cost of borrowing which is then tested against the arm’s length principle.
(Details of the composition of thin capitalisation agreements are at INTM582000 onwards.)
