OT22052 - Interest and Financing

Thin Capitalisation Interest as distribution ICTA 88/s209(2)(e)(iv) or s209(2)(da)

Where the interest rate on borrowing from a connected party overseas is acceptable but the amount of the debt exceeds what would have been found between unconnected parties acting at arm’s length, there are statutory provisions which treat the interest on the excess level of debt as a distribution.

For payments made before 29th November 1994 ICTA88/s209(2)(e)(iv) provided that all interest paid to a non resident parent or a non-resident fellow 75% subsidiary of the non- resident parent should be treated as a distribution and was not therefore allowable as a charge. Note that the section was of wide application in view of the definition of security in ICTA88/s254(1).

ICTA88/s209(2)(e)(iv) was however widely overridden by double taxation agreements. Further guidance on the interaction between the section and Double Taxation Agreements can be found in earlier editions of this Manual.

Because ICTA88/s209(2)(e)(iv) had a varying impact dependent on the interaction with a double taxation treaty, the section was repealed in FA95 and replaced with a clear arm’s length approach. This is provided by ICTA88/s209(2)(da) which applies to payments made on or after 29th November 1994 (for most loans). The requirement to look at the level of debt arises in ICTA88/s209(8)(b) which, in conjunction with ICTA88/s808A(2) to (4), makes clear that consideration must be given not only to the amount and terms of the debt but also to whether the loan would be made at all.