INTM582040 - Thin capitalisation: agreements between HM Revenue & Customs and the group: Length of the agreement

The thin cap agreement should explicitly state how long it is intended to last. When thin cap agreements were linked to treaty clearances, the usual duration of the clearance would be for five years or until the end of the loan, whichever was shorter, and the thin cap agreements followed that pattern.

Even without the connection to the clearance, five years remains a sensible maximum for a thin cap agreement. Even at that length, it may be sensible to have elements within the agreement which should be open to review at shorter intervals. It is quite reasonable for the agreement to provide for an aspect about which there is particular uncertainty or unpredictability to be highlighted for review after a couple of years - for example, how further acquisitions are to be funded, or whether restrictions on dividends need to be reviewed. This can be optional or obligatory, but need not bring the entire agreement to a halt or open it up for wholesale revision. If, in exceptional circumstances, an agreement is made for longer than five years, it should certainly contain a fairly sweeping provision for periodic review.

The appropriate duration of an agreement will depend on a number of factors, each of which influence how much time should elapse before it is sensible to re-examine the position. Some relevant factors may be:

• whether the group is expanding, contracting or in a steady state - see INTM578070 and INTM578080. For example, if the UK group has recently acquired other businesses at the time of the application for treaty clearance, such that financial ratios different from the norms would be acceptable on a temporary basis, it may be advisable to revisit the capitalisation position after two or three years. This might be achieved either by making a thin cap agreement for the shorter period or for a longer time but with provision for a review after three years. The solution in such circumstances is more usually to agree a set of ratios that move, year by year, towards ones which reflect a “steady state” position, but in some cases that may be going too much into the unknown.
• a situation in which there is doubt about the ability of the UK group to fulfil the financial conditions of the agreement. In such a case it might be wiser to agree a shorter length of agreement and check the situation after a couple of years. This does not necessarily mean that the borrower will be subject to the same degree of scrutiny as when the agreement was first discussed. A review could concentrate on the particular elements of uncertainty.
• that the UK group believes that in a few years’ time its situation will have improved sufficiently for it to obtain more favourable arm’s length conditions than currently. It might be possible to write such conditions into the agreement in the first place, but the company has the option to seek different agreement terms if circumstances change sufficiently to warrant a renegotiation. It might be possible to accommodate this within one agreement, but the likely uncertainty as to outcome and the sheer fact that loan terms would be changing suggest that a shorter-term agreement running up to the renegotiation is a practical solution.
• that the UK group is likely to be radically different in structure or size or activity in a few years’ time, so that the current agreement would not be appropriate and a new one would need to be discussed. In fact, the prospect of such an eventuality is usually built in as a fairly standard term; that if the borrower changes radically, it can come back and discuss the possibility of renegotiating in the light of changes.