INTM582030 - Thin capitalisation: agreements between HM Revenue & Customs and the group: Interest rate

The agreement should explicitly state the rate of interest to be charged over the duration of the treaty clearance.

This may be expressed in a number of ways in third-party agreements:

• as a fixed rate
• in a formulaic way for a floating rate, in terms of a reference rate plus a margin, for example LIBOR + 3.75%, or EURIBOR + 375 basis points basis points (the figure is purely illustrative)
• as a range of rates dependent on the financial position of the borrower. For example, if the borrower can hit targets such as specified debt:EBITDA ratios which indicate that its financial position is improving or has stabilised, this will reduce the risk to the lender, the interest rate may be reduced slightly, and vice versa. This can be set out in tabular form.

Of course, the rate must be the agreed arm’s length rate for the particular situation

The interest rate is one of the basic building blocks of the agreement, and any attempt by the group to vary it during the term of the agreement or to leave it inadequately defined should be strongly resisted. If there is any mechanism in accordance with which the interest rate changes, it should be fully understood and dealt with within the terms of the agreement at the outset.

Third party agreements often set out a range of interest rates, so that the margin varies in response to changes in other parameters; for example, the rate might reduce if the debt:EBITDA ratio improves, reflecting decreased risk to the lender.

As below: