INTM501010 - Interest imputation: transfer pricing the lender: tax implications of outward lending

The arm바카라 사이트檚 length principle, as endorsed in OECD guidance and applied in UK transfer pricing legislation (INTM432010 onwards), applies to the lending and borrowing of money just as it applies to the purchase and sale of goods and the provision of services. Article 9 of the OECD Model Tax Convention says that the arm바카라 사이트檚 length principle should be applied where:

바카라 사이트�바카라 사이트onditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises바카라 사이트�

and this obviously includes the provision of funding.

Thin capitalisation, covered in the modules at INTM542000 and INTM510000, looks at the borrower, while this chapter concerns transfer pricing aspects of the taxation of the lender, usually a UK company lending to other group companies, within or outside the UK. Other financial transfer pricing issues arise in this outward facing context, such as guarantee and other fees, but this chapter concentrates on lending.

The relevant legislation is within S446 CTA09 (on loan relationship treatment of transfer pricing adjustments) and Part 4 of TIOPA10, which replaced ICTA88/SCH28AA and has effect for all accounting periods ending on or after 1s t April 2010.

The term 바카라 사이트渙utward lending바카라 사이트� really reflects the position before 2004, when transfer pricing did not generally apply to UK/UK transactions. Perhaps 바카라 사이트渙nward lending바카라 사이트� is more appropriate. However, the term usefully distinguishes the transfer pricing of lending from the transfer pricing of borrowing (thin capitalisation), where the tags 바카라 사이트渋nward investment바카라 사이트� or 바카라 사이트渋nward lending바카라 사이트� are similarly out-of-date, but still convenient shorthand.

At arm바카라 사이트檚 length, lenders generally expect a commercial return on their money, reflecting the level and types of risk involved. There are many sound commercial reasons why lending takes place between members of the same group of companies: efficient money management, economies of scale, the advantages of concentrating the strength of a group centrally in negotiations with a third party lender, sharing temporary surpluses, the benefits of running 바카라 사이트渋n-house바카라 사이트� treasury functions such as cash pooling, but these should all be rewarded in line with services provided on an arm바카라 사이트檚 length basis. There is specific guidance at INTM503000 on the activities of treasury and group finance companies.

Interest imputation

Where the thin cap legislation applies, it produces a reduction in finance costs in the borrower바카라 사이트檚 tax computations. Interest imputation focuses on the lender, and it is a matter of increasing (sometimes from zero) the UK lender바카라 사이트檚 reward for making the money available. A transfer pricing adjustment only applies for tax computation purposes; it does not entail creating or increasing an actual interest charge. For this reason, the interest is said to be 바카라 사이트渋mputed바카라 사이트� as income of the lender for tax purposes.

Participatory relationship provision

TIOPA10/S148 requires a 바카라 사이트減articipatory relationship바카라 사이트� between the parties for the legislation to apply. This is equivalent to the 바카라 사이트渟pecial relationship바카라 사이트� mentioned in the old legislation at ICTA88/SCH28AA. See INTM542020 on the pre-conditions that have to be in place for these transfer pricing rules to be applicable.

The lender-borrower relationship

Aspects of arm바카라 사이트檚 length and non-arm바카라 사이트檚 length lending and borrowing are considered in detail in the modules on thin capitalisation at INTM540000 and INTM570000. Many of the practical concerns and considerations covered there apply here, though with different emphasis because those modules are largely concerned with the borrower. Guidance is therefore not duplicated and the focus here is on particular aspects of outward lending.

If the borrower is offshore, it may not be possible to look closely at the borrower, and focus will naturally be on the UK entity which may not to be getting an arm바카라 사이트檚 length reward. Pragmatically, it may be better in these cases to agree a reasonable rate of return for the lender rather than becoming embroiled in issues connected with the borrower.

The lender바카라 사이트檚 reward

When considering whether the lender is getting an inadequate return one should consider the options realistically available. The UK lender may lose the benefit of having the funds available for other, possibly more lucrative purposes, including other investments, meeting trading expenses, research and development, etc. It may be obliged to borrow to make up the shortfall. The company may even be borrowing to lend, without making a 바카라 사이트渢urn바카라 사이트� on the transactions. Where the company has the role of arranger or guarantor of the loan, it may not receive proper payment for the work it has done.

Where investment is made by way of a loan, there are a number of different ways in which the lender may lose out some examples are:

  • no interest is charged, or the rate charged is less than an arm바카라 사이트檚 length rate. Transfer pricing legislation applies to the provision of the loan (see INTM501020 and INTM501040).
  • whether interest is nominally charged or not, it may be claimed that the recipient company is thinly capitalised and cannot service the debt, so no interest is recognised in the tax computations.
  • it may be claimed, correctly or not, that the loan is performing an equity function, and that interest should not be charged (see INTM502010).
  • payment of interest may be deferred without a commensurate adjustment in the interest rate