Thinly capitalised companies and multiple group guarantors

Problem with thinly capitalised companies and multiple group guarantors, if foreign exchange losses arise

Since 1 April 2004, thin capitalisation is assessed on a company-by-company basis. This means assessing the creditworthiness of each group company that has borrowings by looking only at its own assets and liabilities, including of course within its assets shares it owns in subsidiaries. If it owes more debt that it could support on a third party basis, that can only mean that there are actual or implicit guarantees by group companies.

The rules require self assessment. Where a company is thinly capitalised, it must disallow tax relief for an appropriate part of its interest expense and foreign exchange losses.

The legislation, which is set out in ICTA 1988 schedule 28AA paragraph 6D, does however allow the guarantor to claim tax relief for the amounts disallowed. Para 6D(2) gives relief to the guarantor where interest or other amounts payable have been disallowed to the borrower under 6D(1)(c). This works fine with a single guarantor, as para 6D(2) deems the guarantor to stand in the shoes of the borrower in respect of the disallowed amounts.

However, my colleague Keith MacKeith has recently noticed a “bear-trap” in the wording of the legislation.

If there are two or more guarantors, you need a provision to ensure that they don’t claim, in aggregate, more than was disallowed to the actual borrower. This limitation rule is set out in para 6D(3). The problem is that this limits the aggregate guarantor deductions to an amount, TR, which is the amount disallowed under 6D(1)(c) which expressly links to para 1(2). This however fails to include foreign exchange losses, which in the case of thinly capitalised borrowers are disallowed by a separate provision, paragraph 11A Schedule 9 FA 1996. The conclusion is that with two guarantors, neither of them can claim a deduction for the disallowed foreign exchange losses. This does not seem to have been intended, but follows from the wording of the law.

The problem does not arise with one guarantor. While para 6D(2) also refers back to 6D(1)(c), once you have had some interest disallowed under para 1(2) the deeming provision of 6D(2) is enough to pick up all of the disallowed foreign exchange losses. With two guarantors however, 6D(3) contains a numerical limitation to the amounts disallowed under 6D(1)(c).

We have raised the point with the HMRC, but pending any response groups should think carefully before giving multiple guarantees within a group if the borrower may be thinly capitalised and exposed to foreign exchange differences.

Mohammed Amin