TP Back to Basics – The HMRC ATCA Process

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This article is accompanied by a slide presentation on YouTube. Feel free to use my material for your own in-house purposes, all I ask is that you acknowledge the source.


The UK’s corporation tax self-assessment regime requires the taxpayer to ensure that their transfer pricing reflects arm’s length conditions for all their controlled transactions, including UK-UK.

Interest arising on connected party debt is a simple means of avoiding tax by shifting profit from one jurisdiction to another and is therefore an obvious target for tax authority scrutiny.

However, an Advance Thin Capitalisation Agreement (ATCA) with HMRC will give a business certainty regarding the UK deductibility of interest arising on its connected party debt, and a properly considered and carefully drafted ATCA application should address HMRC’s potential concerns and give the applicant the certainty it desires without too much inconvenience.

For the avoidance of doubt, the UK’s corporate interest restriction rules that came into effect from 1st April 2017 impose a potential additional restriction on finance costs after other tax rules, including transfer pricing and thin capitalisation, have been applied. Therefore, ATCAs remain relevant and the certainty given by an ATCA will still be of value to many groups.

Thin capitalisation can a complex area of transfer pricing and so HMRC encourages the use of ATCAs as an effective way to discuss and resolve thin cap matters in real time.

This article draws on HMRC thin capitalisation guidance from their International Manual, which you can find at INTM511000 onwards, and Statement of Practice 01/12, which reflects HMRC’s current practice on ATCAs. It concludes with my thoughts on good practice regarding ATCA applications.

This is the second in a series of articles which examines official recommendations and guidelines on transfer pricing matters and it is accompanied by a slide presentation on YouTube. Original wording has been retained in places for clarity and the avoidance of doubt.

As the HMRC manual is freely available online, it can give groups and their advisors an insight into HMRC processes and policies and into how HMRC specialists are trained to deal with transfer pricing and thin cap cases. This is an extremely useful insight to have as it should enable you to better manage your relationship with HMRC and tailor your ATCA application to suit HMRC’s preferences.

Creating the ATCA

The ATCA process is normally initiated by the business, as an application for clarification by agreement of the effect of applying the arm’s length principle to the financial provisions between the business and its lenders.

An ATCA should be clearly and carefully drafted, and cover all aspects of the agreement between HMRC and the business. All important terms and ratios referred to in an ATCA must be clearly defined within the agreement.

It makes sense to start with HMRC’s Model ATCA and modify it as required. Statement of Practice 01/12 and the Model ATCA are reproduced in HMRC’s International manual at INTM520085 et seq as follows:

INTM520085 Statement of practice 01/12
INTM520090 The model ATCA
INTM520100 The model ATCA – appendix 1 – interest cover ratio
INTM520110 The model ATCA – appendix 2 – gearing ratio
INTM520120 The model ATCA – appendix 3 – short accounting period
INTM520130 The model ATCA – commentary on the agreement

A typical Advance Thin Cap Agreement will deal with the following:

The maximum amount of the loan or loan facility

The value of the borrower’s subsidiary companies can be taken into account when assessing its debt capacity and so references to “stand-alone entity” actually refer to the borrowing unit, which might be the UK holding company and several subsidiaries.

Whilst monitoring covenants (see below) may effectively place an arm’s length cap on borrowing, HMRC often requires that the agreed level of arm’s length debt is also stated explicitly in the ATCA. This may include all the borrower’s debt, i.e. connected party and third party, to make the agreement more durable.

Depending on the facts and circumstances of the case, an ATCA can also allow limits for additional borrowing without having to re-visit the agreement. However, it would normally stipulate an overall reduction in debt over the term.

The arm’s length principle is embedded in UK transfer pricing legislation so there are no safe harbours and each case is considered on its merits. Therefore, HMRC does not give “safe” debt:EBITDA or debt:equity ratios but does set out some broad principles in INTM517040 in relation to debt that should be considered. Here is a selection:

  • Debt:EBITDA is favoured as a ratio more often than debt:equity because of its link to cash, although financial trades may find a debt:equity measure more appropriate. Whatever measure is deemed appropriate, the ratio required by lenders can vary considerably between business types. Some businesses may be thinly capitalised even on ratios that are easily sustainable for others.
  • Companies in a particular business sector may tend towards a typical borrowing profile and so a review of comparable businesses with third-party debt may help identify an arm’s length ratio for the controlled transaction under review.
  • A third-party lender may be prepared to accept a “debt spike” for a number of years after an acquisition. An ATCA can recognise this but will set ratios that step-down the allowable debt to steady state levels over the term.
  • Business model will also be a factor. Private equity acquisitions, for example, are likely to be more highly leveraged than “traditional” business models.
  • Publicly-quoted UK companies tend to stay within a debt:equity limit and ratios greater than 0.6:1 are rare unless exceptional circumstances apply.

The interest rate

The interest rate is another fundamental element of an ATCA and so HMRC will not accept any attempt by a group to include wording which gives it discretion to vary the rate, except within clearly defined and agreed limits.

The interest rate can be defined as a fixed rate, a floating rate (e.g. LIBOR +x.y%), a cap (below which it can vary) or as a range tied to the borrower’s financial position (e.g. the interest rate is tied to the borrower’s debt/EBITDA ratio)

HMRC applies the arm’s length principle to all the terms of the controlled debt, including interest rate and advises staff to consider the following when examining interest rates:

  • Is there a credible comparable uncontrolled price? Tax advisors may quote bond issues by similar companies at similar times, but these need to be scrutinised carefully, particularly when the period in question is one of volatility, or a lack of market confidence exists amongst lenders.
  • Does the company have any third party borrowing or has it had any definite offers of third party funding which might provide a starting point for establishing an appropriate arm’s length interest rate for the controlled transaction?
  • Is challenging the rate likely to be cost effective? If not, the case team is likely to accept your proposals and move on to their next case.

Start and end date for the duration of the agreement

An ATCA should clearly express its duration, which would normally be three to five years, although in certain circumstances it can exceed five years, e.g. where past years are included. However the current year and future component cannot exceed five.

The financial conditions to be fulfilled by the UK borrower (i.e. monitoring covenants)

Monitoring covenants are another a key element of an ATCA. HMRC will not accept an ATCA without them. So you must include ratios that define the arm’s length position for each year covered by the ATCA.

HMRC will normally require two such ratios, one debt related and the other interest related, typically debt/EBITDA and EBITDA/interest. The debt cap referred to above is regarded by HMRC as an additional feature of an ATCA rather than a main covenant.

The ATCA must also include a statement of what will happen should the borrower fail to comply with one or more of the financial conditions, i.e. to explain how any disallowed interest should be calculated. If the borrower fails to meet both financial conditions, the greater disallowance of the two will apply.

For the avoidance of doubt, worked examples of monitoring covenant calculations are appended to the ATCA.

Note that the ratios used as covenants in third party loan agreements act as triggers to alert the lender that something may be amiss with the borrower and that some action may need to be taken. They are liquidity or performance ratios, normally linked to EBITDA, which must be maintained within certain levels, being set to allow some flexibility around the business’s performance projections before an alert is triggered. They do not define what the lender was prepared to lend.

However, the ratios in an ATCA serve a different purpose. They determine the limits of arm’s length borrowing. Therefore, arm’s length covenants can’t be applied to an ATCA without some adjustment.

Covenant breaches and unforeseen circumstances

An ATCA should include an explicit statement about unexpected circumstances which would have a significant effect on the business and which may result in a breach of covenant. Broadly speaking these will be one-off, unexpected events that fall outside of normal business experience and therefore may invoke some leniency by a third party lender.

HMRC recognises that there may be scope for different interpretations of “unexpected circumstances” but state that it should be possible to establish an understanding of what kind of breach should merit leniency.

Additional Clauses

The above sections set out the basic features of an ATCA. However, they may not cover every situation and so additional sections may be required, such as:

  • A clause covering transfer pricing treatment of cash retained by the UK company, e.g. because the connected lender does not want it repaid.
  • A declaration that an interest-free loan will remain interest-free throughout the term of the ATCA.
  • A statement that any capital contributions or interest free loans will remain in place for the duration of the ATCA.
  • A clause specifying the proportions of debt and cash/equity which will be applied to future acquisitions.
  • A clause to restrict dividend payments in order to avoid the situation where all profits are paid up as dividends while acquisitions are debt funded.

Signing off the ATCA

After satisfying the HMRC governance process two copies of the ATCA must be signed on behalf of both parties, with one copy to be retained by each.

A signed ATCA between the group and HMRC represents a binding undertaking on the parties that the treatment of the transfer pricing issues covered by the agreement will, for the specified period, be determined in accordance with the agreement. Therefore, a self-assessment return made by the business on any other basis in relation to those matters during the period of the ATCA will constitute an incorrect return, with possible penalty consequences.

Presenting your ATCA application to HMRC

You should make your ATCA application as close as possible in time to the controlled debt transactions. HMRC recommends that the application letter includes the information listed below, and that any subsequent discussions are face-to-face or conference call rather than correspondence.

  • A group structure covering all companies playing any part in the trading activities, funding and control of the borrower(s), and clearly setting out any changes to the structure taking place over the course of the debt transactions.
  • A description of the borrower’s business, its trading strategy and the plans of the principal trading operations.
  • A description of the financing structure being put in place, setting the context within which it has come into being, e.g. the commercial motivations/advantages/ pressures of the chosen course of action, both from the UK and the wider group perspective, and an assessment of the degree of risk attaching to the controlled loans.
  • A clear identification of the source of the funds, outlining the purpose for which they were borrowed and how the expected benefits to the UK business justify the costs and repayment terms.
  • The quantum of the actual/predicted benefits of the object of the funding: e.g. assets, income streams, realignment, etc, as specifically and completely as is possible.
  • A summary of contemporaneous financial forecasts, identifying their source and purpose, projected for the proposed life of the ATCA and presenting a realistic range of potential outcomes
  • A description of the borrower’s strategy for managing the debt, both interest and principal, over the period of the ATCA (and beyond, if relevant), including how and when amounts will be repaid, identifying the principal cash flows and the sources of repayment of the debt and how much is expected to be refinanced at the terminal date.
  • Copies of all loan agreements and other relevant documents.
  • A draft ATCA, or a clear set of proposals for one.

HMRC criteria for acceptance of an ATCA application

HMRC has not published any fixed criteria, e.g. turnover or level of debt, regarding acceptance of an ATCA application with or without enquiry.

Whilst Statement of Practice (01/12) says that “The process is designed to help resolve financial transfer pricing issues which have a significant commercial impact on an enterprise’s results, where the issues would be unlikely to be regarded as “low risk” by HMRC, or where the arm’s length provision is a matter of doubt”, HMRC states that it is not prescriptive in this respect.

Therefore, applications are only likely to be returned because they are inadequate in some respect. If an application is returned it is likely to be accompanied with a request to complete it properly and resubmit.

HMRC’s transfer pricing governance rules also apply to thin cap enquiry work but ATCA applications are subject to less detailed governance. However, an ATCA will not be signed off by HMRC until it has been reviewed by at least one authorised person who has not been closely involved in the case, and larger cases will be reviewed by a transfer pricing governance panel.


So, what can we take from all of the above?

There is useful guidance material on how HMRC would prefer to see ATCA applications made and most of it is common sense.

An ATCA application is unlikely to be refused unless it’s inadequate in some way. Therefore  applications are more likely to be accepted and quickly dealt with where they are comprehensive, clearly presented and accompanied by a draft agreement proposing reasonable terms.

However, acceptance of your application doesn’t mean that HMRC will agree with your proposals. You may still have to spend time ensuring that the case team understands your business and how you’ve arrived at your arm’s length position, so that their analyses and conclusions are based on a proper understanding of the facts and circumstances of the case and therefore more likely to agree with yours.

But forewarned is forearmed. Prior knowledge of what might trigger HMRC scrutiny will enable you to lessen that risk and there are steps you can take to reduce the risk of a serious challenge. There are no guarantees but here are some suggestions.

Tips and good practice 

  • Connected party debt is a simple profit-shifting device so HMRC will scrutinise your ATCA application very carefully. But if your application is detailed, comprehensive, with a draft agreement based on HMRC’s model and you take a reasonable position then HMRC may decide that it’s not cost-effective to challenge and it could be agreed fairly quickly. On the other hand, if it is sketchy or deficient in any way and/or you take an aggressive position, expect a rejection or worse, a lengthy enquiry.
  • HMRC’s view is that, for the purposes of an ATCA, a borrower of connected party debt cannot, under any circumstances, use an interest rate greater than that actually charged on the debt in question, even if the actual rate can be shown to be lower than the arm’s length. This is relevant in situations, for example, where the amount of controlled debt is greater than what could/would be borrowed at arm’s length but with an interest rate that is lower than an arm’s length lender would charge, and the net effect of the two is an interest expense equivalent to that arising from the arm’s length amount of debt at the arm’s length interest rate. HMRC’s view in this scenario is that the amount of allowable debt is the smaller arm’s length amount and the interest rate remains at the lower actual rate, resulting in an allowable interest expense which is arguably less than arm’s length. You may not agree with this interpretation of the relevant sections of Chapter 4 TIOPA2010 but, to the best of my knowledge, no advisor or group has felt confident enough to test HMRC’s interpretation at a Tribunal. So, I would recommend that you avoid this scenario if at all possible.
  • It may facilitate your application to include copies of the financial forecasts provided to your third party lenders (if you have any) along with your ATCA-specific forecasts and an explanation of any differences. This will demonstrate that you have nothing to hide and may give HMRC some comfort regarding the overall credibility of your application.
  • Be open and cooperative. Do your best to ensure that the HMRC case team fully understands your business and the evidence you’ve gathered to demonstrate that your controlled debt is on an arm’s length basis. If you do then at least they’ll be basing their analyses and conclusions on accurate facts and information. Early, regular and open communication with HMRC is essential.
  • Your ATCA should include a statement of the maximum amount of total borrowing if possible. This can include some headroom over and above the amount initially borrowed to allow further borrowing to take place, e.g. for acquisitions, without breaching the agreement. On the other hand where, for example, funding is at a maximum in the wake of a major acquisition it would be wise to limit your ATCA to debt in existence at the time of the agreement, particularly where the ATCA relates to a private equity case.
  • A loan which has outlived its purpose may be vulnerable to challenge under CTA09/S441.


I try to make the contents of this website as useful, reliable and factual as possible but any opinions that slip through are solely my own.

The purpose of the site is to inform and educate readers with guidance and useful tips. It provides only an overview of the regulations and guidance in force at the date of publication and is not a substitute for professional advice. The contents are not designed to provide professional advice or financial advice and should not be relied on as such.

You should not base any action on the contents of this website without first obtaining specific professional advice, tailored to the facts and circumstances of your situation, from an appropriately qualified Transfer Pricing expert.

No responsibility for loss occasioned by any person acting or refraining from action as a result of the contents of this Website can be accepted by the author.


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