TTM07500 - The Ring Fence: Interaction of finance costs and transfer pricing

The transfer pricing rules (described in TTM07300 onwards) and the finance cost allocationrules (described in TTM07400 et seq) are two distinct sets of tools which are used toensure that an appropriate part of the overall profits of a tonnage tax company or group is brought into charge outside the ring fence.

Basic principles

Where there are any intra-group loans across the ring fence, the transfer pricing rules should be applied before the finance cost allocation rules are applied to the group.

Any interest paid on intra-group loans across the ring fence (including any interest imputed under the transfer pricing rules) should be taken into account in arriving at the ‘just and reasonable’ amount of the external finance costs which may be allowed as a deduction outside the ring fence under the finance cost allocation rules.

In most cases it will be appropriate to add the full amount of any interest paid (or imputed) on such loans to the amount which would have been regarded as just and reasonable if the intra-group loan had not been taken into account when applying the finance cost allocation rules.

As explained at TTM07400 onwards, the finance cost allocation rules are intended to placea limit on the amount of the external finance costs which may be claimed as a deduction outside the ring fence. Therefore, subject to the limited exceptions mentioned below, an adjustment may only be made if the amount of the third party finance costs actually charged outside the ring fence exceeds the ‘just and reasonable’ amount (calculated as described above).

Interest-free loans used as an alternative to equity investment

Many shipping groups use intra-group interest-free loans from one UK company to another as a more flexible alternative to an equity investment. Under the transfer pricing rules, interest is not imputed on loans which cross the ring fence if they are properly regarded as performing an equity function - i.e. where, and to the extent that, the loan renders the debtor company thinly capitalised.

However, the fact that an interest-free loan is made as an alternative to an equity investment does not in itself mean that the loan is performing an equity function. So, in practice, the transfer pricing rules will operate to impute interest on such loans where they cross the ring fence. If, exceptionally, any part of the loan is actually performing an equity function (i.e. the debtor is thinly capitalised), then interest will only be imputed on the balance of the loan.

References