INTM547010 - Thin capitalisation: financial transactions - ICTA88/SCH28AA

Provisions of ICTA88/SCH28AA

ICTA88/SCH28AA applies to all accounting periods of UK companies ending on or after 1 July 1999 where:

• provision has been made or imposed between any two persons by means of a transaction or series of transactions and
• at the time of the making or imposition of that provision

(i) one of the persons was directly or indirectly participating in the management, control or capital of the other, or

(ii) the same person/s was or were directly or indirectly participating in the management, control or capital of each of them

• the provision made or imposed differs from the provision which would have been made between independent enterprises (the arm’s length provision)
• this creates a potential advantage in relation to UK taxation on one of the persons.

In these circumstances the profits or losses of the potentially advantaged person shall be computed for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision.

For further information on participation in the management, control or capital of a person, see INTM432080.

For the meaning of an advantage in relation to UK taxation see ICTA88/SCH28AA/PARA5(1). Basically there is an advantage where the actual provision gives rise to lower taxable profits or higher allowable losses than would have been the case had the provision been at arm’s length.

There is no definition of ‘provision’ in the legislation but this is interpreted to encompass all the terms and conditions attaching to a transaction or a series of transactions (see INTM432040).

Transaction is however widely defined to include ‘arrangements, understandings and mutual practices (whether or not they are, or are intended to be, legally enforceable)’. ‘Arrangements’ are further defined at ICTA88/SCH28AA/PARA3(5) to mean ‘any scheme or arrangement of any kind (whether or not it is, or is intended to be, legally enforceable)’.

Clearly this legislation can be applied in situations where a UK borrower is thinly capitalised and in several respects it is wider in its application than ICTA88/S209(2)(da) ( Inspectors should note that S209(2)(da) was repealed with effect from 1 April 2004 and ICTA88/SCH28AA was amended with effect from that date. See INTM560000 et seq for further details.). ICTA88/S209(2)(da) can only apply where there is a narrowly defined relationship between borrower and lender, as explained at INTM544040, whereas ICTA88/SCH28AA can apply in a broader set of circumstances. The main advantage of the new legislation however is that it can be applied to indirect finance. See INTM547020 for details.