INTM542020 - The main thin capitalisation legislation: The basic precondition and the participation condition
The basic precondition
TIOPA10/S147 (previously SCH28AA/PARA1) sets out the “basic pre-condition” for transfer pricing legislation to apply, which is, in summary:
When a provision (“the actual provision”) is made or imposed between any two connected persons (“the affected persons”) by means of a transaction or series of transactions (INTM542040) and that provision differs from the provision which would have been made between independent enterprises (“the arm’s length provision”).
If this “basic precondition” is met, and as a result, a UK tax advantage (INTM542030) is conferred on one or both parties, then the profits or losses of the advantaged person are to be calculated for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision.
“Person” includes a body of persons, corporate or unincorporated, so includes entities such as companies, charities or partnerships - see INTM432060.
The participation condition
TIOPA10/S147(1)(b) says that for the “basic pre-condition” to be engaged, the “participation condition” must be met. This is defined in TIOPA10/S148(2) (Previously SCH28AA/PARA 4).
The parties are called the “affected persons” and must be connected in one of the following ways at the time the actual provision was made or imposed, or at any time within six months of the date that the actual provision was made or imposed:
- one of the affected persons was directly or indirectly participating in the management, control or capital of the other; or
- the same person or persons was or were directly or indirectly participating in the management, control or capital of each of the affected persons.
Participation in the management, control or capital of a person is defined at TIOPA10/S157 - S160 by reference to rights and powers, both actual and potential. The definitions extend the basic notion of participation beyond that of parent-subsidiary or subsidiary-subsidiary. For more detail on the application of these provisions, see INTM432060 and INTM432070.
Control
Control, which forms part of the definition of special relationship, is defined at CTA10/S1124, (formerly ICTA88/S840), as:
- In relation to a body corporate (“company A”), “control” means the power of a person (“P”) to secure-
- by means of the holding of shares or the possession of voting power in relation to that or any other body corporate; or
- as a result of any powers conferred by the articles of association or other document regulating that or any other body corporate,
- that the affairs of company A are conducted in accordance with P’s wishes.
The definition of control is extended further in certain circumstances by TIOPA/S161 and TIOPA/S162 - see INTM542150. The “acting together” provisions (the commonly-used term from the previous legislation at Sch 28AA), are referred to in TIOPA10 as an aspect of “indirect participation”, and this concept can apply very widely, extending beyond situations which meet the specific requirements of the “participation condition”. These provisions are most frequently relevant in a Private Equity context or where the borrower is in financial distress (INTM580040 onwards).
