INTM583020 - Thin capitalisation: breaches of agreement between HM Revenue & Customs and the group: Cessation of treaty clearance
Older thin capitalisation agreements were explicitly linked to treaty clearance applications. They were in effect statements of some of the conditions under which HM Revenue & Customs granted clearance for interest to be paid gross (or under deduction at the treaty rate) to an overseas lender. The thin cap agreement was a conditional treaty clearance under SI1970/488: if the terms of the thin cap agreement were breached, the clearance might be forfeit. In practice such difficulties were usually resolved by a disallowance of interest in the tax computation, and/or an injection of equity or reduction of debt.
The position will be the same in respect of those Advance Thin Capitalisation Agreements (ATCAs) for which there is a treaty clearance issue, in that they define how much interest may be paid at the treaty rate (the arm’s length portion), and if there is “excessive”, non-arm’s length interest in any year, that will not be covered by the clearance. In the event that covenants forming part of an ATCA are breached, HMRC might be obliged to reconsider the treaty clearance provided in respect of the related financing provisions. However, as before, the aim would be to deal with the breach using the remedies laid down within the agreement, the primary one being a disallowance of interest sufficient to “restore” the ratios in the ATCA i.e. sufficient interest would be disallowed to reduce the interest deduction to an amount which did not breach any of the covenants. The adjustment might stem from “excessive” debt or “excessive” interest, the disallowance being based on which ever breach was the largest.
If the application of the agreement results in a disallowance, the compensating adjustment legislation may be available to the lender under ICTA88/SCH28AA/PARA6C, or to UK companies of the global group who have the borrowing capacity to offset the disallowance, under ICTA88/SCH28AA/PARA6D. See INTM542180 and INTM542190.
If the option of suspending or terminating the treaty clearance is an available and becomes necessary, clearance will cease at least until the covenant breach is rectified. Withholding tax obligations would resume.
Such a failure may indicate a need to review whether the terms of the agreement are still appropriate, going forward.
