TP SEMINAR SLIDES FEB 2010

DEBT MARKETS AND TRANSFER PRICING OF

INTERCOMPANY DEBT - AN UPDATE

26 February 2010

Copyright © March 10 BDO LLP. All rights reserved.

Client name - Event - Presentation title

Page 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

HSBC Debt Finance Origination

UK debt market - The latest trends and developments

26 FEBRUARY 2010

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

5

How we got here….

• Up to the end of 2007 the bank debt market was characterised by over-supply and virtually infinite liquidity

• Due to the laws of supply and demand the cost of liquidity reduced dramatically to historical lows

• With banks chasing deals to deploy assets, transactions also bore a 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

Comment re

pricing?

Credit spreads reached

unprecedented highs

in Q4 2008 following Lehman’s collapse and

widespread concerns regarding global

macroeconomic conditions

6

Cycles in the Loan Market

2008/

9

2004

Higher risk tolerance

2005

Longer maturities

2006

Weakening of credit

standards

2006/7Lower

differentiation between risks

2008Higher

margins

2009More

differentiation between risks

Start 2008Restricted

lending policies

End 2007Credit losses

2002Low margins

for prime risks

2003

Banks looking for assets

7

Current Market Conditions

• Pricing has increased dramatically in the post crunch era, although it has stabilised and is beginning to tighten for borrowers at the top end of the credit spectrum, however there remains a premium for any new money requirements

• Structures will continue to be conservative

• - lower debt multiples

• - amortising debt

- - financial covenants,

- restrictions on additional indebtedness

- limited appetite for deals beyond three years

- underwriting appetite remains constrained

• Banks remain focused on the need for ancillary business to satisfy 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

Sustained co ordinated government and central

bank intervention has

sought to bolster banks’balance sheets and

‘unlock’ liquidity, assisted also by the fall in

LIBOR/interbank levels and a renewed ability for

banks to access

wholesale funding.

The key pockets of liquidity to support UK Corporates continue to

reside with the four UK clearing banks

Conservative structures

based around ‘Club’arrangements

8

Expectations for 2010

• A push on tenor is inevitable and is already evident with recenttransactions stretching to 3.5 to 4 years maturity. However a limited number of banks are able to offer these terms and companies should expect to pay a premium

• Pricing will tighten over the coming months for companies with astrong credit profile

• Structures will continue to be conservative with a focus on amortising debt and covenants

• Non UK banks will come back into the marketplace as they are 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

Greater market liquidity overall but a continued focus on pricing, tenor

and structure and a lower volume of deals

Selective use of bank

balance sheets will continue

Signs of support for mid –market borrowers from

Svenska, Bank of Ireland, Kfw and Bank of China

(latter focus on

investment grade credit)

9

HSBC in the Market

We are a relationship focused bank looking to

lead on deals with quality

credits priced for risk

We have the ability to provide customers with

the means to address a ‘funding gap’ as the

economy undergoes a

process of deleveraging

• Throughout the ‘credit crisis’ HSBC remained firmly open for business and has increased lending to the mid market sector and will continue to do so

• Active new customer acquisition program – 20% of 2009 transactions for new customers

• c. 30 middle market corporate transactions completed in 2009

• 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 todiversify their capital structure

10

£588 million

Term and Revolving credit facilities

Mandated Lead Arranger and Bookrunner

February 2009

William Hill PLC

$550 million

Acquisition facilities

Mandated Lead Arranger and Bookrunner

March 2009

Premier Oil plc

Recent Deals

£70 million

Revolving credit facilities

Mandated Lead Arranger

September 2009

St Ives plc

£90 million

Revolving credit facilities

Mandated Lead Arranger

May 2009

The BSS Group plc

$175 million

Acquisition facilities

Mandated Lead Arranger

May 2009

Micro Focus International Plc

€110 million

Revolving credit facilities

Mandated Lead Arranger

September 2009

Gerber Juice Company Ltd

$135 million

Revolving credit facilities

Mandated Lead Arranger

September 2009

Purolite

£350 million

Convertible Bond

Bookrunner

September 2009

Tui Travel Plc

£210 million

Revolving credit facilities

Mandated Lead Arranger

May 2009

Misys PLC

EUR300 million

Revolving credit facilities

Mandated Lead Arranger

April 2009

Shanks PLC

£200 million

Revolving credit facilities

Mandated Lead Arranger

February 2009

Clifford Chance LLP

£135 million

Revolving credit facilities

Mandated Lead Arranger

February 2009

Genus Plc

11

Contact Details

• SPEAKER:

• David C Stephens

• Director

• Debt Finance Origination

• HSBC Corporate and Structured Banking

• T: 020 7991 1328

• M: 07771 841 067

• E: david.c.stephens@hsbcib.com

REST OF TEAM:

Andy Smith

Head of Debt Finance Origination

T: 020 7991 1394

M: 0771 7690 884

E: andy.smith@hsbc.com

Matt J Osborne

Director

Debt Finance Origination

T: 020 7991 1485

M: 07795 684 689

E: matt.j.osborne@hsbcib.com

Ben Handler

Associate Director

Debt Finance Origination

T: 020 7991 5552

M: 07920 082122

E: ben.handler@hsbcib.com

THE TRANSFER PRICING OF

INTERCOMPANY DEBT AND

INTERESTAnton Hume

Head of Transfer Pricing

anton.hume@bdo.co.uk

Copyright © March 10 BDO LLP. All rights reserved.

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)

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

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

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

HMRC’S APPROACHDetermine 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

Senior debt

Mezzanine debt

Senior debt

Allowable shareholder debt70% LTV

Allowable shareholder debt50% LTV

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

0

1

2

3

4

5

6

7

2007 2008 2009 2010

Mu

ltip

le (

x1)

Debt to EBITDA

EBITDA Interest Cover

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

HMRC’S APPROACH – ACHIEVING CERTAINTYHMRC 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

INTRA-GROUP FINANCING

• Trends

• Complexities

• Example

• Our experience

• Overseas financing

INTRA-GROUP FINANCING - TRENDSThe 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

INTRA-GROUP FINANCING - COMPLEXITIESDifficulty 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

INTRA-GROUP FINANCING - EXAMPLEProblem

• 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

US Parent

UK Hold co

Trade 1 Trade 2 Trade 3

INTRA-GROUP FINANCING - OUR EXPERIENCEWe 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

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

LEVERAGED BUYOUTS

• Trends

• Complexities

• Our experience

LEVERAGED BUYOUTS - TRENDSLess 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

LEVERAGED BUYOUTS - COMPLEXITIESAggressive 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

LEVERAGED BUYOUTS - OUR EXPERIENCEWe 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)

ECONOMIC SUPPORT

• Interest rates

• Quantum of debt

• Compensating adjustments

• Our experience

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

SUPPORTING QUANTUM OF DEBTWhat 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

THE ISSUE OF COMPENSATING ADJUSTMENTSTransfer 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

OUR EXPERIENCE OF WORKING WITH HMRCWe 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

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

WORLDWIDE DEBT CAP

A tax raising measure with limited interest?

Richard Bertini

Copyright © March 10 BDO LLP. All rights reserved.

WDC BREAKFAST SEMINARContents

• Tax treatment of financing costs

• A brief WDC overview

• Planning and anti-avoidance

• WDC anomalies

• Other practical aspects

• Ongoing issues

TAX RELIEF FOR FINANCING EXPENSE

An historical perspective

TAX RELIEF FOR FINANCING EXPENSE I

2009 (ie 1 BC) – UK is a dumping ground for debt?

Distribution rules

UK companyincurs interest

Transferpricing

Thin capitalisation

Corporate debtrules

Arbitragerules

Other anti-avoidance

Corporation taxrelief

for interest

TAX RELIEF FOR FINANCING EXPENSE II

2010 (ie now) – UK still attractive to business?

Distribution rules

UK companyincurs interest

Transferpricing

Thin capitalisation

Corporate debtrules

Arbitragerules

Other anti-avoidance

Corporation taxrelief

for interest

Worldwide debt cap

WORLDWIDE DEBT CAP

A brief overview

WDC – THE MISCHIEF

Treasury/HMRC policy objective:

Relief for UK financing costs

should not exceed a group’s gross

external financing costs

UK Sub

Parent

Bank

External debt of

£10m owing to Bank

>75 per cent

Internal debt of

£100m owing to Parent

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

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

WDC – WHO’S LARGE

EC Recommendation 03/361 – Annex (6.5.03)

Does the group have 250 employees or more?

Is the group’s annual turnover €50m or more?

Is the group’s annual balance sheet total €43m or more?

The groupis large

The groupis not large

No

Yes

No

No

Yes

Yes

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

WORLDWIDE DEBT CAP

Planning and Anti-Avoidance

WDC PLANNING & ANTI-AVOIDANCE IHeadline 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?

WDC PLANNING & ANTI-AVOIDANCE IIGT, 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

WDC PLANNING & ANTI-AVOIDANCE IIIGeneral 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

WDC PLANNING & ANTI-AVOIDANCE IVOther 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

WDC PLANNING & ANTI-AVOIDANCE VFurther 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

WDC ANOMALIES

Observations and examples

WDC ANOMALIES IExternal debt matters – a tale of two groups

You might expect the debt cap to penalise debt laden groups…

£m

Black groupTested expense amount 10Available amount 1Disallowed amount 9

Red groupTested expense amount 10Available amount 10Disallowed amount nil

Foreignparent

Bank

UKsubsidiary

Foreignparent

UKsubsidiary

>75% >75%

£1m paexternalinterestpayable

£10m paexternalinterestpayable

£10m painternalinterestpayable

WDC ANOMALIES II

Foreign tax matters – an unwelcome surprise

Black group may also have non-UK tax implications…

£m

Foreign parentInterest receivable 10Interest payable 1Taxable amount? 9

UK subsidiaryTested expense amount 10Available amount 1Disallowed amount! 9

Foreignparent

Bank

UKsubsidiary

>75%

£1m paexternalinterestpayable

£10m painternalinterestpayable

WDC ANOMALIES IIIDisregard derivatives – synthetic debt is ignored

Interest rate hedging, cross currency swaps and other synthetic borrowings are not taken into account…

£m

Brown groupTested expense amount 10Available amount 9Disallowed amount 1

Purple groupTested expense amount 8Available amount 9Disallowed amount nil

Foreignparent

Bank

UKsubsidiary

Foreignparent

UKsubsidiary

>75% >75%

£9m pa floatingrate interest

£8m pafixed

pay £10m fixed

receive £9mfloating

pay £8m fixed

receive £9mfloating

£10m pafixed

WDC ANOMALIES IV

Gateway test – accounting figures can skew results

Non-arm’s length internal borrowings can adversely affect the gateway test, which uses amounts taken from financial statements…

£m

GT accounting resultsUK net debt 140Worldwide group gross debt 100GT failed > 75%

GT arm’s length positionUK net debt (£140m @ 50%) 70Worldwide group gross debt 100GT passed < 75%

Foreignparent

Bank

UKsubsidiary

>75%

£100mexternaldebt

£140minternaldebt

[50% arm’slength]

WDC ANOMALIES V

Gateway test – domestic groups will always fail

But in theory there should be no net disallowance…

£m

Grey groupTested expense amount 11Available amount 2Disallowed amount 9

Income exemption- UK parent 9

Overall disallowance nil

UKparent

UKsubsidiary

>75%

£2m painterest onshareholder

debt

£9m paintercompany

interest

- -~

WDC ANOMALIES VIDe minimis limits – unintended consequences

In practice an overall debt cap disallowance could arise within domestic groups…

£m

Blue groupTested expense amount 2.0Available amount 1.2Disallowed amount 0.8

Income exemptions (up to £0.8m)UK Sub 1 (<£0.5m) nil UK Sub 2 (<£0.5m) nil

UKparent

Bank

UKsub 1

UKsub 2

>75%

£0.4m painternalinterestpayable

£1.2m pa externalInterest payable

£0.4m painternalinterestpayable

WDC ANOMALIES VII

Interaction with late interest rules – bad timing

Late interest accruing after 2009 could lead to an unfair permanent disallowance…..

£m

Scarlet groupYear 1 (2010):Tested expense amount 1Available amount 2Disallowed amount nil

Year 5 (2014):Tested expense amount 9Available amount 2Disallowed amount 7Exempt income 1Net disallowance (Y1-3) 6

UKparent

UKsubsidiary

>75%

£2m painterest onshareholder

debt[payable endof year 5]

£1m paintercompany

interest

- -=

WORLDWIDE DEBT CAP

Other practical aspects

WDC PRACTICAL POINTS IOpportunities

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

WDC PRACTICAL POINTS IICompliance 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

WDC ONGOING ISSUES

Prospective changes and consultation Issues

WDC RETROSPECTIVE CHANGESKnown 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

WDC PROSPECTIVE CHANGESKnown 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

Thank you

Any questions?

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