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On 26 February we held a transfer pricing event which focused on debt markets and transfer pricing of intercompany debt.

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  1. 1. DEBT MARKETS AND TRANSFER PRICING OF INTERCOMPANY DEBT - AN UPDATE 26 February 2010 Copyright © March 10 BDO LLP. All rights reserved.
  2. 2. AGENDA 8.45am – 9.00am Current corporate finance market – BDO Current UK and European debt markets – HSBC 9.00am – 9.15am Questions 9.15am – 9.45am Transfer pricing and intercompany debt 9.45am – 10.00am Questions 10.00am – 10.30am Worldwide debt cap 10.30am – 10.45am Questions and close Client name - Event - Presentation title Page 2
  3. 3. HSBC Debt Finance Origination UK debt market - The latest trends and developments 26 FEBRUARY 2010
  4. 4. Agenda • How we got here… • Cycles in the Loan Market • Current Market Conditions • Expectations for 2010 • HSBC in the Market • Recent Deals • Contact Details 4
  5. 5. How we got here…. Credit spreads Comment re • Up to the end of 2007 the bank debt market was characterised by reached pricing? highs unprecedented over-supply and virtually infinite liquidity in Q4 2008 following Lehman’s collapse and • Due to the laws of supply and demand the cost of liquidity reduced widespread concerns dramatically to historical lows regarding global macroeconomic • With banks chasing deals to deploy assets, transactions also bore a conditions higher risk tolerance, longer maturities and both credit standards and structures were weakened (i.e. ‘cov-lite’ deals) • However, credit markets reached near melt-down in Q4 2008 following Lehman’s collapse and widespread concerns regarding global macroeconomic conditions • Banks’ funding costs soared with banks unable to fund themselves at or near to LIBOR, leading to a “freezing” of interbank lending with many banks funding themselves from central banks • With liquidity in short supply and demand from borrowers unrelenting cost of debt increased significantly 5
  6. 6. Cycles in the Loan Market 2003 2006 2004 2005 Banks looking Weakening Higher risk Longer for assets of credit tolerance maturities standards 2002 2006/7 Low margins for prime risks 2008/ Lower differentiation between risks 9 2009 Start 2008 More 2008 End 2007 Restricted Credit losses differentiation Higher lending between risks margins policies 6
  7. 7. Current Market Conditions Sustained co ordinated government and central • Pricing has increased dramatically in the post crunch era, although bank intervention has it has stabilised and is beginning to tighten for borrowers at the top sought to bolster banks’ end of the credit spectrum, however there remains a premium for balance sheets and any new money requirements ‘unlock’ liquidity, assisted also by the fall in • Structures will continue to be conservative LIBOR/interbank levels and a renewed ability for • - lower debt multiples banks to access wholesale funding. • - amortising debt The key pockets of - - financial covenants, liquidity to support UK - restrictions on additional indebtedness Corporates continue to reside with the four UK - limited appetite for deals beyond three years clearing banks - underwriting appetite remains constrained Conservative structures • Banks remain focused on the need for ancillary business to satisfy based around ‘Club’ arrangements overall return on capital targets • Overseas banks have retrenched to domestic markets • Corporates have focused on deleveraging to reduce reliance upon bank debt funding with record levels of rights issues used to repair their balance sheet 7
  8. 8. Expectations for 2010 Greater market liquidity • A push on tenor is inevitable and is already evident with recent overall but a continued focus on pricing, tenor transactions stretching to 3.5 to 4 years maturity. However a and structure and a lower limited number of banks are able to offer these terms and volume of deals companies should expect to pay a premium Selective use of bank balance sheets will • Pricing will tighten over the coming months for companies with a continue strong credit profile Signs of support for mid – • Structures will continue to be conservative with a focus on market borrowers from Svenska, Bank of Ireland, amortising debt and covenants Kfw and Bank of China (latter focus on • Non UK banks will come back into the marketplace as they are investment grade credit) given a green light to start lending • Ability and willingness to underwrite is set to increase, although it will be restricted to good quality credits • Diversified capital structures for increased stability • Access to alternative financing in the form of Rights Issues, Private Placements, corporate or convertible bonds and high yield bonds to reduce reliance upon bank debt 8
  9. 9. HSBC in the Market We are a relationship focused bank looking to • Throughout the ‘credit crisis’ HSBC remained firmly open for lead on deals with quality business and has increased lending to the mid market sector credits priced for risk and will continue to do so We have the ability to provide customers with • Active new customer acquisition program – 20% of 2009 the means to address a transactions for new customers ‘funding gap’ as the economy undergoes a • c. 30 middle market corporate transactions completed in 2009 process of deleveraging • We are keen to lead transactions at Mandated Lead Arranger level and support this role via higher hold levels for good quality credits • Although pricing is set to tighten HSBC will continue to price for risk • We are comfortable to lend beyond three years, however we will not drive the market there on our own • We have the ability and expertise to assist customers looking to diversify their capital structure 9
  10. 10. Recent Deals February 2009 February 2009 February 2009 March 2009 Genus Plc Clifford Chance LLP William Hill PLC Premier Oil plc £135 million £200 million £588 million $550 million Revolving credit facilities Revolving credit facilities Term and Revolving credit facilities Acquisition facilities Mandated Lead Arranger Mandated Lead Arranger Mandated Lead Arranger and Bookrunner Mandated Lead Arranger and Bookrunner April 2009 May 2009 May 2009 May 2009 Shanks PLC The BSS Group plc Micro Focus International Plc Misys PLC EUR300 million £90 million $175 million £210 million Revolving credit facilities Revolving credit facilities Acquisition facilities Revolving credit facilities Mandated Lead Arranger Mandated Lead Arranger Mandated Lead Arranger Mandated Lead Arranger September 2009 September 2009 September 2009 September 2009 St Ives plc Gerber Juice Company Ltd Purolite Tui Travel Plc £70 million €110 million $135 million £350 million Revolving credit facilities Revolving credit facilities Revolving credit facilities Convertible Bond Mandated Lead Arranger Mandated Lead Arranger Mandated Lead Arranger Bookrunner 10
  11. 11. Contact Details • SPEAKER: REST OF TEAM: • David C Stephens Andy Smith • Director Head of Debt Finance Origination • Debt Finance Origination T: 020 7991 1394 • HSBC Corporate and Structured M: 0771 7690 884 Banking E: • T: 020 7991 1328 Matt J Osborne • M: 07771 841 067 Director • E: Debt Finance Origination T: 020 7991 1485 M: 07795 684 689 E: Ben Handler Associate Director Debt Finance Origination T: 020 7991 5552 M: 07920 082122 E: 11
  12. 12. THE TRANSFER PRICING OF INTERCOMPANY DEBT AND INTEREST Anton Hume Head of Transfer Pricing Copyright © March 10 BDO LLP. All rights reserved.
  13. 13. THE UK ENVIRONMENT FOR TAX RELIEF FOR FINANCING EXPENSES - A MINEFIELD! • Thin capitalisation (thin cap) • Transfer pricing • Anti-arbitrage provisions • Corporate debt provisions • Distribution rules • Other anti-avoidance • Worldwide debt cap (WDC)
  14. 14. INTRODUCTION – WHY WE ARE HERE? Thin cap attracts a lot of tax authority attention There can be significant amounts of tax at stake • It is complex area for TP - the risks and returns seen in financial markets are more volatile than seen by your usual ‘cost-plus’ service provider! • There is no OECD guidance (and little HMRC guidance) as to how to address it Impact of HMRC adjustments • Reduced interest deduction = increased taxable profit • Double taxation • Penalties on unpaid tax • WHT on interest
  15. 15. WHAT I’D LIKE TO CONVEY TO YOU TODAY • Some of the lessons we have learned about HMRC’s approach to thin cap • How BDO go about supporting interest rates and the quantum of allowable debt • How to achieve certainty on your thin cap position • How to deal with the consequences of any adjustment • Some observations (hopefully useful!) as we go along
  16. 16. STRUCTURE • An overview of HMRC’s approach • Intra-group financing – particular considerations • Intra-group financing – outbound financing • Leveraged buyouts – particular considerations • Economic support • Consequences of adjustments and compensating adjustments • Our experience of working with HMRC
  17. 17. HMRC’S APPROACH Determine the amount and terms of debt which would be obtained from a third party in the context of: • Financial covenants – loan to value (LTV) Pre credit crunch – Post credit crunch - leveraged buyouts leveraged buyouts 70% LTV Allowable shareholder debt Mezzanine debt 50% LTV Allowable shareholder debt Senior debt Senior debt
  18. 18. HMRC’S APPROACH (CONT.) Determine the amount and terms of debt which would be obtained from a third party in the context of: • Financial covenants – debt to EBITDA, EBITDA interest cover Trends in financial covenants seen in third party financing arrangements 7 6 5 Multiple (x1) 4 Debt to EBITDA 3 EBITDA Interest Cover 2 1 0 2007 2008 2009 2010
  19. 19. HMRC’S APPROACH (CONT.) Determine the amount and terms of debt which would be obtained from a third party in the context of: • Financial forecasts at the inception of the financing arrangement • Arrangement fees • Risk assumed • The strength of the company and the nature of the industry in which it operates • Seniority and nature of debt • Currency used • Guarantees
  20. 20. HMRC’S APPROACH – ACHIEVING CERTAINTY HMRC introduced the ATCA process in October 2007 • Replaced COP10 procedure – now strict ‘arm’s length standard’ applied (both by reference to the amount and terms of the debt) and binding by statute • COP 10 - dealt with by HMRC in a legalistic and heavily caveated manner often leaving the taxpayer with little certainty. COP 10 left the taxpayer open to subsequent HMRC enquiry and a possible reassessment • ATCAs can be used for UK-UK financing (such as those involving PE investors) although they are only a unilateral agreement • ATCAs can also be used for certainty on interest rates, guarantee fees and quasi-equity arguments for loans made by UK taxpayers
  21. 21. INTRA-GROUP FINANCING • Trends • Complexities • Example • Our experience • Overseas financing
  22. 22. INTRA-GROUP FINANCING - TRENDS The global financial crisis has limited the availability of once plentiful and relatively inexpensive external funding • Many companies are not meeting the covenants set under existing thin cap agreements with HMRC, or have experienced a sustained period of below par performance, such that thin cap has now become an issue • Lack of guidance from the OECD, and more aggressive tax authorities, increases the double taxation risk
  23. 23. INTRA-GROUP FINANCING - COMPLEXITIES Difficulty of verifying business valuations and parent co. guarantees • Unlike management buyouts, the re-financing of intra-group debt tends to take place with less / no due diligence regarding the borrower’s business, especially where it is not ‘new’ debt associated with an acquisition • Also, third party banking covenants (as a possible external ‘CUP’) may not be helpful due to the existence of cross guarantees • Furthermore, ‘pass-through’ loans are unlikely to be a suitable CUP • Is it possible to borrow against goodwill? • Issues with assessing the borrowing capacity of the borrowing company – notional intra-group guarantees and compensating adjustments • Other corporate tax issues: • World wide debt cap • Arbitrage rules • Loans for unallowable purposes
  24. 24. INTRA-GROUP FINANCING - EXAMPLE Problem US Parent UK Hold co Trade 1 Trade 2 Trade 3 • If finance is provided to UK Hold co, one cannot consider Trade 3 in isolation – need to look at the borrowing capacity of the consolidated UK group • Therefore more complex than private equity backed acquisitions • It is important to have consolidated UK accounts to determine the arm’s length borrowing capacity of the UK group • If existing group is financially weak, this could impact upon the thin cap position relating to the acquisition of further companies
  25. 25. INTRA-GROUP FINANCING - OUR EXPERIENCE We have dealt with HMRC on many cases • These cases tend to be the most complex, and allowable amounts of debt tend to be lower due to the factors outlined above • Lending criteria likely to be tighter for intra-group financing than on leveraged buyouts – HMRC will make reference to the ‘conservative nature of UK lenders’(!) and the fact that the debt : equity ratios of the FTSE top 200 companies are ‘significantly less than 1:1’ • To maximise the allowable interest deductions we recommend: • Re-negotiate any “COP10” agreements still in place, even where covenants have not been broken • Prepare consolidated UK forecasts, and document the commercial rationale behind the debt finance • The best deals are agreed where HMRC feels the debt is in place in the UK for a legitimate commercial purpose, and there is a strong business model backing up the arrangement • For ‘smaller’ deals (generally under £100m), we have been able to agree a fixed LTV proportion, with no financial covenants to meet
  26. 26. INTRA-GROUP FINANCING – OVERSEAS FINANCING • Most countries have safe harbour rules – some for amounts of debt, and some (eg USA) for interest rates • When providing funds overseas, advice is needed in multiple jurisdictions • Do I always need to charge interest on intra-group loans? • UK equity function concept – would a third party lender offer funding? BUT need to consider - Legal form important - Accounting presentation - Legal agreements - Board minutes
  27. 27. LEVERAGED BUYOUTS • Trends • Complexities • Our experience
  28. 28. LEVERAGED BUYOUTS - TRENDS Less common since the credit crunch / fall in asset prices • The volume and amounts of leverage seen in buyouts has fallen considerably in the last two years • The above chart shows a fall in total debt to EBITDA ratios seen in Western Europe LBOs from a height of 5.91:1 in Q1 2008 to 4.11:1 in Q4 2009
  29. 29. LEVERAGED BUYOUTS - COMPLEXITIES Aggressive levels of leverage, and complex instruments • Generally, several ‘tranches’ of debt, of varying seniority and security • Debt on buyouts of international groups may have been novated to individual entities in the UK • Interest is being paid in the form of ‘PIK’ notes, effectively increasing the indebtedness of the company over time • The structure of repayments (senior debt being repaid, new PIK notes being issued) can lead to the level of debt not changing, but the allowable interest deduction falling over the period of the financing, if a fixed proportion of the debt at inception is treated as allowable
  30. 30. LEVERAGED BUYOUTS - OUR EXPERIENCE We have dealt with HMRC on many cases • It is important to model the changes in the level of each tranche of debt over the length of the financing arrangements to help negotiate a position that can be easily understood by all parties • Prior to the credit crunch, it was possible to agree an allowable proportion of debt with a LTV of upwards of 70 per cent. However, now HMRC is likely to agree a LTV of somewhere between 45 per cent and 60 per cent • HMRC places a great deal of emphasis on financial covenants on third party debt. Unfortunately, the use of these as a CUP is flawed, as they tend to be based on a ‘headroom’, rather than the most aggressive financial covenants a third party would be prepared to offer • HMRC tends to relax senior debt covenants by 10-12 per cent for subordinated debt (pre credit crunch, this was 10-12 per cent for mezzanine finance and a further 10-12% for junior debt)
  31. 31. ECONOMIC SUPPORT • Interest rates • Quantum of debt • Compensating adjustments • Our experience
  32. 32. SUPPORTING INTEREST RATES • Search for CUPs using primary loan issue information, however the perfect CUP will not exist • Search for loan price by loan rating, loan size, issue date and loan type (Reuters Dealscan, Bloomberg) • Most comparables are floating rate, but fixed rate loans are better for corporate and tax planning • Consider using credit default swap rates as a proxy to price loans • It is not appropriate to use the same interest rates throughout an international group, as each country’s ‘borrowing unit’ will have a different borrowing capacity, and there will be local differences in interest rates
  33. 33. SUPPORTING QUANTUM OF DEBT What are the relevant factors to consider? Banking facilities tend to include financial covenants for: debt to EBITDA, EBITDA interest cover Banks tend to consider the following factors: Security, cash flow, industry, state of economy and prevailing economic climate for the business Analytical tools Modelling credit rating, then search for loans • Type of loan – LBO, acquisition, revolver, general corporate purposes, distressed debt • Financial covenants specified - Debt to EBITDA etc But - OECD guidelines indicate you can have a level of debt even if not observable with comparables if it is economically justified
  34. 34. THE ISSUE OF COMPENSATING ADJUSTMENTS Transfer Pricing legislation should protect against double tax charge • Investors, whether body corporates or individuals, are within the scope of the transfer pricing legislation when lending funds in ‘a businesslike way’ • As such, an investor can ensure that he is not treated as having received taxable interest payments to the extent that the borrower does not receive a deduction for interest under the arm’s length standard • A key question is whether at arm’s length, the ‘provision’ of finance would have taken the form of equity, or would not have occurred at all • Investors must be mindful of this uncertainty when planning their tax position in relation to any disallowance of interest
  35. 35. OUR EXPERIENCE OF WORKING WITH HMRC We have built up a good working relationship with several TP specialists at HMRC • Increasingly experienced and sophisticated in their approach • Variable pragmatism • Role of TP panel • Attitude to ATCAs • Appetite for thin cap enquiries • Our qualitative approach to the business and the industry it operates in: • gives HMRC more confidence about the strength of the company • enables check on reasonableness of capital structure • Our economic analysis gives HMRC reassurance about current lending patterns • Our headroom sensitivity analysis offers transparency to HMRC and the client on the interest deductibility
  36. 36. SUMMARY • Thin cap adjustments can have a very significant impact on a corporate’s tax charge • One of the most complex areas of transfer pricing • No OECD guidance is available • HMRC is increasingly experienced at financing transactions and is also increasingly challenging them
  37. 37. WORLDWIDE DEBT CAP A tax raising measure with limited interest? Richard Bertini Copyright © March 10 BDO LLP. All rights reserved.
  38. 38. WDC BREAKFAST SEMINAR Contents • Tax treatment of financing costs • A brief WDC overview • Planning and anti-avoidance • WDC anomalies • Other practical aspects • Ongoing issues
  39. 39. TAX RELIEF FOR FINANCING EXPENSE An historical perspective
  40. 40. TAX RELIEF FOR FINANCING EXPENSE I 2009 (ie 1 BC) – UK is a dumping ground for debt? UK company incurs interest Distribution rules Transfer Thin pricing capitalisation Arbitrage Corporate debt Other anti- rules rules avoidance Corporation tax relief for interest
  41. 41. TAX RELIEF FOR FINANCING EXPENSE II 2010 (ie now) – UK still attractive to business? UK company incurs interest Distribution rules Transfer Thin pricing capitalisation Arbitrage Corporate debt Other anti- rules rules avoidance Worldwide debt cap Corporation tax relief for interest
  42. 42. WORLDWIDE DEBT CAP A brief overview
  43. 43. WDC – THE MISCHIEF Bank Treasury/HMRC policy objective: Relief for UK financing costs should not exceed a group’s gross External debt of external financing costs Parent £10m owing to Bank >75 per cent Internal debt of £100m owing to Parent UK Sub
  44. 44. WDC HEADLINE ISSUES The debt cap is already a reality • WDC is a blunt tax raising instrument • Restricts the availability of tax relief for finance expense • Applies for periods of account commencing after 31 December 2009 • Many will escape the worst by passing the gateway test • Some will suffer significant financing disallowances • Compliance obligations are onerous • Anti-avoidance targeted at manipulation of WDC • Legislation is still being fine-tuned, with retrospective effect • Limited time or opportunity to correct inherent defects • Does not apply to banks
  45. 45. WDC – WHO’S AFFECTED? Is there a large group? • ‘Group’ is defined by IAS • ‘Large’ group uses EU definitions Relevant group company means • UK company or non-UK company trading in UK via UKPE which is either: - the ultimate parent of worldwide group or - a 75 per cent subsidiary of the ultimate parent Gateway test • Groups with debt mainly in UK will fail test - eg many outbound and domestic groups
  46. 46. WDC – WHO’S LARGE EC Recommendation 03/361 – Annex (6.5.03) Does the group have 250 employees or more? Yes No No Is the group’s annual turnover €50m or more? Yes Yes No Is the group’s annual balance sheet total €43m or more? The group The group is large is not large
  47. 47. WDC CURRENT RULES Arrangement of the legislation • Primary legislation – Schedule 15 Finance Act 2009 • SI 2009/3173 - CT (Financing Costs & Income) Regulations • SI 2009/3217 - CT (Acceptable Financial Statements) Regulations • SI 2009/3313 - CT (Exclusion from Short Term Loan Relationships) Regulations • Coming soon: - Taxation (International & Other Provisions) Act 2010 (rewritten primary legislation) - Finance Bill 2010 (retrospective changes to TIOPA 2010, draft released with PBR) - Accounting mismatches regulations - Structured finance and quasi loan mismatch regulations - Excluded schemes regulations
  48. 48. WORLDWIDE DEBT CAP Planning and Anti-Avoidance
  49. 49. WDC PLANNING & ANTI-AVOIDANCE I Headline thoughts • Is there a “group” (IAS definition) • Which entity is the “ultimate parent” (WDC definition)? • If there is a group is it large (EU definition)? • Are there any relevant group companies (WDC definition)? • Can RGCs be disregarded for the gateway test (NDA <£3m)? • Can RGCs be disregarded for the disallowance (NFD <£0.5m)? • Can financing income of UKGCs avoid de minimis (NFI >£0.5m)? • Could surplus funds be imported into UK? • Is there scope to increase external non-UK borrowings? • Is there a magical derivative financial instrument available?
  50. 50. WDC PLANNING & ANTI-AVOIDANCE II GT, TEA, AA & TIA Anti-Avoidance Manipulation of gateway test: • Scheme entered into before end of relevant period • Without the scheme GT would be failed • Passing GT is (one of the) main purpose(s) of scheme • Scheme is not an excluded scheme Manipulation of debt cap disallowances or exemptions: • Scheme entered into before end of relevant period • Reducing relevant net deduction is (one of the) main purpose(s) • Scheme achieves a reduction of UKGC profits or increase in losses • Scheme is not an excluded scheme
  51. 51. WDC PLANNING & ANTI-AVOIDANCE III General Anti-Avoidance HMRC published examples of acceptable planning: • Repay debt with surplus cash or proceeds from loan repayment • Debt waivers and capitalisation • Transfer liability to a UK group treasury company • Increasing overdraft to fund working capital • Borrowing (no more than needed) to fund acquisition or share buy-back • Acquiring assets under FLs or external factoring of trade debts • Unwinding old intra-group financing arrangements • Bona fide intra-group financing
  52. 52. WDC PLANNING & ANTI-AVOIDANCE IV Other Anti-Avoidance EEA financing income exemption: • Scheme entered into before financing income received • Scheme results in EEA financing income • Securing EEA financing income is (one of the) main purpose(s) • Scheme is not an excluded scheme Change of period of account of worldwide group: • No longer relevant • Countered attempts to defer start date of WDC
  53. 53. WDC PLANNING & ANTI-AVOIDANCE V Further comments • Legislation is framed to allow swift counteraction via regulations • HMRC code of practice on taxation for UK banks • Excluded schemes regulations not a top priority • HMRC unlikely to challenge acceptable planning included in published guidance • WDC anti-avoidance non-statutory clearance: - requires commercially significant material uncertainty - HMRC will not bless tax planning or opine on purpose - available pre or post transaction
  54. 54. WDC ANOMALIES Observations and examples
  55. 55. WDC ANOMALIES I External debt matters – a tale of two groups You might expect the debt cap £1m pa £10m pa to penalise debt laden groups… external external interest Bank interest payable payable £m Black group Tested expense amount 10 Available amount 1 Foreign Foreign parent parent Disallowed amount 9 £10m pa Red group internal interest Tested expense amount 10 >75% >75% payable Available amount 10 Disallowed amount nil UK UK subsidiary subsidiary
  56. 56. WDC ANOMALIES II Foreign tax matters – an unwelcome surprise Black group may also have non- £1m pa UK tax implications… external interest Bank payable £m Foreign parent Interest receivable 10 Interest payable 1 Foreign parent Taxable amount? 9 £10m pa UK subsidiary internal interest Tested expense amount 10 >75% payable Available amount 1 Disallowed amount! 9 UK subsidiary
  57. 57. WDC ANOMALIES III Disregard derivatives – synthetic debt is ignored Interest rate hedging, cross pay £8m fixed pay £10m fixed currency swaps and other receive £9m Bank receive £9m synthetic borrowings are not floating floating taken into account… £9m pa floating rate interest £m Foreign Foreign Brown group parent parent Tested expense amount 10 Available amount 9 Disallowed amount 1 £10m pa £8m pa >75% fixed fixed >75% Purple group Tested expense amount 8 UK UK Available amount 9 subsidiary subsidiary Disallowed amount nil
  58. 58. WDC ANOMALIES IV Gateway test – accounting figures can skew results Non-arm’s length internal Bank borrowings can adversely affect £100m the gateway test, which uses external amounts taken from financial debt statements… £m Foreign GT accounting results parent UK net debt 140 Worldwide group gross debt 100 £140m GT failed > 75% internal debt >75% [50% arm’s GT arm’s length position length] UK net debt (£140m @ 50%) 70 UK Worldwide group gross debt 100 subsidiary GT passed < 75%
  59. 59. WDC ANOMALIES V Gateway test – domestic groups will always fail - - ~ But in theory there should be no net disallowance… £2m pa interest on £m shareholder Grey group debt Tested expense amount 11 Available amount 2 UK parent Disallowed amount 9 Income exemption £9m pa intercompany - UK parent 9 >75% interest Overall disallowance nil UK subsidiary
  60. 60. WDC ANOMALIES VI De minimis limits – unintended consequences In practice an overall debt cap disallowance could arise within Bank domestic groups… £1.2m pa external £m Interest payable Blue group Tested expense amount 2.0 £0.4m pa UK £0.4m pa Available amount 1.2 internal internal interest parent interest Disallowed amount 0.8 payable payable Income exemptions (up to £0.8m) >75% UK Sub 1 (<£0.5m) nil UK Sub 2 (<£0.5m) nil UK UK sub 1 sub 2
  61. 61. WDC ANOMALIES VII Interaction with late interest rules – bad timing - - = Late interest accruing after 2009 could lead to an unfair permanent disallowance….. £2m pa interest on £m shareholder Scarlet group debt Year 1 (2010): [payable end of year 5] Tested expense amount 1 UK parent Available amount 2 Disallowed amount nil £1m pa intercompany Year 5 (2014): >75% interest Tested expense amount 9 Available amount 2 UK Disallowed amount 7 subsidiary Exempt income 1 Net disallowance (Y1-3) 6
  62. 62. WORLDWIDE DEBT CAP Other practical aspects
  63. 63. WDC PRACTICAL POINTS I Opportunities Income exemptions • Disallowance applies to RGCs (75 per cent subs) • Exemptions apply to UKGCs (51 per cent subs) • Standalone exemption for EEA income Late interest • Pre-2010 deferred interest/discount carved out from FEAs • Possible planning regarding timing of interest payments Quasi group relief features • Disallowances and exemptions can be allocated in the most favourable way
  64. 64. WDC PRACTICAL POINTS II Compliance issues Does WDC apply? • Q&D calculations to determine • May not know for sure till end of POA (eg forex rates) • Have to make QIPs in meantime Reporting aspects • 12 months to file provisional SOAD & SOAE • Complicated if POA of worldwide group differs to APs of UK group! • 36 months to file final SOAD & SOAE • Reporting body and form of returns
  65. 65. WDC ONGOING ISSUES Prospective changes and consultation Issues
  66. 66. WDC RETROSPECTIVE CHANGES Known knowns • Draft FB 2010 clauses and explanatory notes published with PBR • Consultation closed 29 January 2010 • Further changes will be made, which are expected to include: - Gateway test definition of financial assets and liabilities - Exclusion of securitisation companies - Protected company proposals to change - Changes for distributions from industrial and provident societies - Exclusion of LLPs and overseas corporate collective investment scheme vehicles from being the ultimate parent of a group
  67. 67. WDC PROSPECTIVE CHANGES Known unknowns • Interaction with late interest rules • Unintended consequences of de minimis amounts • Refinement of GT definition of relevant assets and liabilities • Accounting mismatch regulations • Inclusion of interest rate hedges and other derivatives • Excluded schemes regulations • Structured finance and quasi loan regulations
  68. 68. Thank you Any questions? Copyright © March 10 BDO LLP. All rights reserved.