INTM563040 - Thin capitalisation: FA2004 legislation - new rules on loan guarantees

Guarantee fees

The thin capitalisation legislation at ICTA88/SCH28AA applies to all parts of the cost of debt finance, including guarantee fees. Paragraph 1 B requires guarantee fees to be disallowed if they lead to an overall increase in the cost of debt finance for the borrower compared to the amount it would have paid as a separate entity. Sub-paragraph (2) refers directly to the cost of a guarantee and sub-paragraphs (4) and (5) require guarantees to be disregarded when considering the interest cost of debt finance.

The total deductions allowable in respect of debt finance, including interest and guarantee fees, should not exceed the amount that the company would have paid as a stand-alone entity. In some cases this will require guarantee fees, if paid, to be wholly or partly disallowed as deductions for the payer. In other cases it may require a guarantee fee to be included in the profits of the guarantor.

If an intra-group guarantee increases the amount of debt and so increases the amount of interest payable by the borrower, it follows that paragraph 1A(4) or 1B(4) will apply, requiring the guarantee to be disregarded. Hence there should be no guarantee fee, but the effect of the guarantee in reducing the interest rate should be taken into account in determining the extent of the interest disallowance. The amount which is deductible for tax purposes in arriving at the assessable profits or allowable losses of the borrower should be the amount the company would have paid in the absence of a guarantee.

If a guarantee does not cause a company to exceed its stand-alone debt capacity, it may have the effect of decreasing the borrower’s interest expense, by reducing the interest rate on the loan. In this circumstance it will be appropriate to take account of an arm's length guarantee fee.

Example 1

Actual debt is £1000 at 5%. In the absence of the guarantee, the maximum debt would have been £500 at 6%

Here the guarantee increases the interest paid from £30 to £50. Therefore interest of £20 should be disallowed. No guarantee fee should be imputed and any guarantee fee paid should be disallowed.

Example 2

Actual debt is £1000 at 5%. In the absence of the guarantee the borrower would still have borrowed £1000 but would have paid interest at 6%.

Here the guarantee reduces the interest expense from £60 to £50, with a corresponding increase in risk for the guarantor. Hence a guarantee fee would be appropriate.