CFM96280 - Interest restriction: related parties: holdings of debt and equity in the same proportions
TIOPA10/S467
The related party rules exist to limit the scope for a related party outside the group using loans and other instruments in place of equity to inflate the interest capacity of the group through the group ratio method or the public infrastructure rules.
A specific risk exists where shareholders in a company lend money on the exact (or very similar) terms and in proportion to their shareholdings in the company. Often such loans are referred to as ‘shareholder loans’ or ‘equity loans’. In such cases, loans effectively form part of the equity in the company.
So, where the amounts each lender has lent to a company, U Ltd, stand in substantially the same proportion as their shares or voting power, and the lenders together have at least a 25% investment in U Ltd, the loans are treated as made between related parties.
In addition, a lender might transfer some, or all, of the rights under the loan to another person. Where this is the case, that person (the transferee) is treated as a related party of U Ltd in relation to the loan, even where they have no shares or voting power in U Ltd.
Example
U Ltd has issued share capital of 100 ordinary £1 shares. These are held as follows:
| Shareholder | Shares Held | Shareholding (%) |
|---|---|---|
| A | 15 | 15% |
| B | 15 | 15% |
| C | 30 | 30% |
| Other third parties | 40 | 40% |
| Total | 100 | 100% |
U Ltd is funded by a £200m bank loan and £60m unsecured loan notes (classed as “A” notes and with the same terms). The loan notes are held as follows:
| Lender | Amount | Proportion |
|---|---|---|
| A | 15 | 25% |
| B | 15 | 25% |
| C | 30 | 50% |
| Total | 60 | 100% |
C is a related party under first principles, as it holds over 25% of the share capital of U Ltd.
When considering S467, the proportion of the shareholdings of A, B and C in U Ltd are calculated by reference to the total shares held by the lenders collectively (rather than by reference to the total shares issued by the company). Therefore, by reference to the 60 shares held collectively, A holds 25%, B holds 25% and C holds 50%.
Under S467, the loans made by A and B are also treated as being made by related parties. The “A” notes are held by A, B and C in the same proportion as the shareholdings in the company held by the lenders.