Chapter INTM503060
| Published date | 09 April 2016 |
| Record Number | INTM503060 |
| Court | HM Revenue & Customs |
| Issuer | HM Revenue & Customs |
In the commercial world, financial businesses are likely to be geared at far higher levels than non-financial businesses. It is therefore quite reasonable to expect a treasury or group finance company to have a significantly higher debt-to-equity ratio than the rest of the group (assuming that the rest of the group is principally engaged in non-financial businesses).
The business activity of a treasury or group finance company operating on commercial terms should be subject to a careful analysis to establish the appropriate level of equity funding. As with all thin capitalisation cases, it is important to consider both gearing (debt-based ratios) and profitability levels in determining what would be accepted and expected at arm’s length. Although debt:EBITDA is the more commonly-used ratio for the general run of trading companies, debt:equity remains the normal key ratio for finance-related companies. The required level of equity is directly linked to the level of risk carried by the company in its borrowing and lending activities. This risk may in reality often be borne by more substantial companies within the group, usually the parent or major trading affiliates.
Where the group finance company of an overseas group is located in the UK, there is a risk that the increased arm’s length debt capacity acceptable for a group finance company is ‘gearing up’ the group’s non-financial activities in the UK. This might arise by debt (either from third parties or from non-resident associates) passing through the UK finance company and into the UK operating companies. If this happens, the finance company is likely to be treated as having a greater borrowing capacity than would be attributed to a trading company. However, if that higher level of debt is passed on to a UK associate, it might not be recognised that the test needs to be applied to the trading company as well.
Gearing up and the “series of transactions”Arrangements to “gear up” a UK non financial group or company may fall within the ‘series of transactions’ provision in TIOPA10/S147(1). It can make a significant difference in some circumstances whether the tripartite arrangements are regarded as “series of transactions” or not.
Example
The overseas lender lends the UK group finance company £100m at interest of 5%. This is on-lent to the UK trading company. The interest flows are
- trading company pays interest of £5m to finance company
- group finance company receives interest of £5m and pays £5m to...
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