Given the many restrictions under UK taxation law for interest deductions (anti-arbitrage, Worldwide Debt Cap, unallowable purpose etc.), the UK Tax Authorities are now offering an informal clearance process alongside Advance Thin Capitalisation Agreements (“ATCAs”). This will run alongside the more formal ATCAs to provide much needed certainty in uncertain tax times.
The UK Tax Authorities (“HMRC”) have recognised that negotiations for formal Advance Thin Capitalisation Agreements (“ATCAs”) should bring in a level of “informal certainty” for the Worldwide Debt Cap (“WWDC”).
Recent Experiences Handling Advance Thin Capitalisation Agreements (ATCAs)
The responsibility for handling ATCAs has been pushed down to local Inspector levels. The historic requirement to involve a transfer pricing specialist in ATCA negotiations has been relaxed and it is now at the judgment of local Inspectors as to whether they loop in technical specialists from International. In practice, whilst it will depend on each case, we find that there is still a good dialogue between local Inspectors and HMRC International on key technical areas arising from ATCAs.
ATCAs and cross-guarantees from sister companies with borrowing capacity
Section 192 of TIOPA101 (formerly paragraph 6D of Schedule 28AA to the Income and Corporation Taxes Act 1988) permits UK companies facing a restriction on interest deductions for thin capitalization to “share” deductions with sister companies in the group that may have borrowing capacity under an informal guarantee type arrangement. HMRC policy is that ATCA negotiations cannot include such claims – however, in practice, HMRC have permitted companies to agree an ATCA which will then have an annual submission of a schedule of interest deductions shared / claimed in the relevant companies. This has the effect of permitting an informal level of certainty.
It will depend on the industry and the transaction although we see HMRC agreeing ATCAs in the following ranges in the current environment (average of ATCAs negotiated in the past 12 - 18 months):
Recent Experiences Handling Worldwide Debt Cap
Companies with December year ends are now nearing the end of their fourth accounting period for which they have had to contend with the WWDC. For those companies, corporate tax departments will be grappling with complex calculations and data extraction to enable them to discharge their compliance obligations when they file the 2012 self-assessment tax returns. In the authors’ view, WWDC remains a wholly unnecessary piece of tax code imposing as it does a disproportionally large compliance burden on those UK companies that fall within its scope.
The WWDC rules were ostensibly devised to prevent multinational companies from exploiting the UK’s generous rules on interest deductibility. What we have seen in practice however is that if one takes the situation of a UK Plc with a large number of subsidiaries it becomes apparent that even where the group has a largely or wholly domestic footprint there is still a large amount of work to be done from a compliance perspective. This is because a wholly domestic group with intragroup lending will often fail the gateway test on account of its aggregate net debt being at least equal to 75% of the group’s external debt. So whilst the gateway test was the mechanism designed to alleviate the onerous compliance burden on those companies that should not have found themselves in the anti-avoidance cross-hairs to begin with, what we are seeing is that the gateway test is generally only of use in an ‘inbound’ context for those overseas headed groups that have large amounts of external financing plainly in issue. For many other groups, a large amount of resource is being devoted to analysis, data manipulation and the preparation of Statements of Allocated Disallowances and Exemptions simply to get back to the position that there is no net disallowance of financing expense.
A further general observation as to the regime’s application is that in our experience HMRC have hitherto been reluctant to apply a ‘light touch’ and it remains as important as ever to apply the rules in a diligent fashion.
In terms of practical tips, there are a number of recurring themes that come up in our work with clients in this area:
- Know Your Group – There are a surprising number of large groups outside of the scope of the regime altogether, due to the mismatch between the accounting definition and the tax definition of “group;”
- Beware of Derivatives – Components of the finance charge relating to movements on derivative instruments need to be adjusted out, which can mean that computing ‘tested amounts’ and the ‘available amount’ is not always straightforward;
- Consider Rationalizing the Structure – Due to the way the gateway test operates, intra-group lending and borrowing can cause the test to be failed notwithstanding that everything nets down to zero
Whilst HMRC’s overtures to include a consideration of WWDC as part of any ATCA negotiations feel like a step in the right direction, it is difficult to see how this would operate in practice. The WWDC provisions are an objective measure of deductible interest expense enshrined on the statute book and it is not within HMRC’s gift to ignore their application. Further in order to give effect the ‘right’ result, it is necessary for taxpayers to make the appropriate returns and elections on an annual basis, which necessitates the performance of the burdensome work described above. The inclusion of WWDC within a holistic approach to obtaining certainty on debt financing really needs to be legislated for, perhaps by extending the scope of those matters that can be covered by advance pricing agreements.
A Co-ordinated Approach
HMRC is offering an informal clearance process where an ATCA is in negotiation and the WWDC is relevant. The change represents an internal policy memo circulated from HMRC International to Inspectors handling ATCAs and is not a legislative change. However, informal certainty is better than none.
1 Taxation (International and Other Provisions) Act 2010