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Journal of International Banking & Financial Law/2009 Volume 24/Issue 11, December/Articles/Thin
Capitalisation - (2009) 11 JIBFL 707
Journal of International Banking and Financial Law
(2009) 11 JIBFL 707
1 December 2009
Thin Capitalisation
Test Claimants in the Thin CAP Group Litigation v Revenue and Customs Commissioners [2009] All
ER (D) 218 (Nov) (Chancery Division) (Henderson J) (17 November 2009)
Jonathan Lawrence
K&L Gates LLP
jonathan.lawrence@klgates.com www.klgates.com
© Reed Elsevier (UK) Ltd 2009
FACTS
Difference in tax treatment means that, in the context of a corporate group, it may be advantageous for a
parent company to finance one of its group subsidiaries by debt rather than equity, particularly if that subsidiary is located in a relatively high tax jurisdiction while the parent is located in a lower tax jurisdiction. This
presentation of what is in substance equity investment as debt finance in order to obtain favourable tax
treatment is 'thin capitalisation'. A parent company can effectively choose where it wishes profits to be taxed.
This judgment resulted from the ruling of the European Court of Justice in March 2007 that the UK's thin
capitalisation rules, prior to 1 April 2004, were, in certain circumstances incompatible with art 43 of the EC
Treaty (freedom of establishment). The case was brought by multinational groups which have invested in
UK-resident subsidiaries by way of loan finance.
CONCLUSION
The UK thin cap rules infringed art 43 at all material times as they failed to provide a separate and independent defence of genuine commercial justification. The effect of the infringement is that the UK thin cap provisions must be disapplied in relation to transactions which had a genuine commercial justification, either in
whole or in any relevant part. Henceforth, the onus would be on HMRC to establish that transactions did not
have such a justification by positive evidence, and not merely as an inference to be drawn from the fact that
the arm's length test under the rules in force at the relevant time was not satisfied. None of the transactions
entered into by the test claimants were purely artificial arrangements devoid of any commercial justification,
nor had HMRC sought to establish that they were. UK thin cap rules had to be disapplied in respect of all
those transactions.
Article 43 is not engaged, and there is no breach of it, where the UK subsidiary to which a loan is made has
an EU resident parent but the lending company is neither itself EU resident nor the subsidiary of an EU resident parent.
The multinationals could seek to claim for the recovery of additional corporation tax actually paid for the use
of trading losses or capital allowances to set off against unlawful tax.