INTM520030 - Thin capitalisation: practical guidance: creating agreements between HMRC and the group: interest rate
The agreement should explicitly state the rate of interest to be charged over the duration of the agreement. This may be expressed in the following ways:
- as a fixed rate.
- in a formulaic way for a floating rate, in terms of a reference benchmark rate plus a margin, for example, overnight SONIA + 3.75% (the figure is purely illustrative).
- as a range of rates dependent on the financial position of the borrower. For example, if the borrower can hit targets such as specified debt/EBITDA ratios which indicate that its financial position is improving or has stabilised, this will reduce the risk to the lender and the interest rate may be reduced slightly. This can be set out in tabular form within the agreement (see bottom of page).
- as a cap - a maximum rate below which the interest rate may fluctuate.
Of course, the rate must be no greater than the arm’s length rate agreed to be applicable for the particular situation. The company cannot use an interest rate greater than that actually charged on the debt, and this rate may be restricted to a lower one if the actual rate is in excess of what would be charged at arm’s length.
The interest rate is one of the basic building blocks of the agreement, and any attempt by the group to leave itself with discretion to vary the rate (except within clearly defined and accepted parameters) or to leave it inadequately defined should be strongly resisted. If there is any mechanism in accordance with which the interest rate changes, it should be fully understood and detailed within the agreement.
Example of tabular presentation
| Total Debt to EBITDA: | Interest margin (LIBOR + % per annum) |
|---|---|
| More than 2.50:1 | 2.25% |
| Equals or is less than 2.50:1 but exceeds 2.25:1 | 1.75% |
| Less than or equal to 2.25:1 | 1.25% |