Funding a UK subsidiary with a loan from the parent
A loan from the parent is the flexible way to fund a UK subsidiary, and the one two separate UK rules can cut back: thin capitalisation tests the loan itself, and the corporate interest restriction caps the deduction once UK interest passes £2 million a year.
A loan from the parent is the flexible way to fund a UK subsidiary, and the one two separate UK rules can cut back: thin capitalisation tests the loan itself, and the corporate interest restriction caps the deduction once UK interest passes £2 million a year.
The four things to know
- Thin capitalisation tests whether a third party would have lent that amount, on those terms
- Below £2 million of UK net interest a year, the corporate interest restriction does not apply at all
- Above it, the deduction is capped at 30% of UK tax-EBITDA, or the group's external interest, whichever is lower
- Interest the restriction disallows is not lost: it carries forward indefinitely
A UK subsidiary funded by its parent gets the money one of two ways: the parent subscribes for shares, or the parent lends it. A loan can be repaid, re-priced and restructured without a company law process, and the interest the subsidiary pays on it is a deduction against UK profit that a share subscription never gives. That flexibility is why most groups use at least some debt, and it is also why two separate UK rules exist to anchor the amount of deductible interest to commercial reality.
Thin capitalisation
Thin capitalisation asks whether an independent lender would have made this loan, at this size and this rate, to a company with the subsidiary's own balance sheet and trading prospects, ignoring the fact that the lender is also the shareholder. A subsidiary with little trading history and few assets to secure a loan against is not a credit an outside bank would extend at the same size, or on the same terms, that a parent might offer informally. Where HMRC concludes the loan is bigger than a third party would have made, or priced more generously than an arm's-length lender would have priced it, the interest on the excess is disallowed, with that part of the loan treated as equity for the purpose of the calculation.
There is no fixed debt-to-equity ratio that settles this on its own. HMRC looks at the subsidiary's own cash flow, assets and trading record, and at what independent lenders in the same industry accept for a borrower in that position. A group unsure of its position can apply for an Advance Thin Capitalisation Agreement, a forward agreement with HMRC that fixes the method for pricing the loan for several years ahead.
The corporate interest restriction
Once a loan has passed the arm's-length test, a second rule can still cut back the deduction: the corporate interest restriction, which caps how much net interest expense a UK group can deduct in a year regardless of who the lender is.
Below £2 million of aggregate net UK interest expense in a 12-month period, the restriction does not apply. No reporting company needs to be appointed and no return has to be filed; the interest is deductible in full, subject to the thin capitalisation test above being met. That £2 million de minimis amount, set by section 392 of the Taxation (International and Other Provisions) Act 2010, is increased or reduced proportionately for an accounting period that does not run to exactly 12 months.
Above £2 million, the default method — the fixed ratio method — limits the deduction to the lower of two figures: 30% of the UK group's aggregate tax-EBITDA (taxable profit before interest, tax, depreciation and amortisation), or the worldwide group's net interest paid to third-party lenders, a backstop known as the debt cap. A UK group lightly funded by outside banks can find the debt cap bites before the 30% figure does, however much headroom the profit-based test would otherwise allow. A group that is more heavily geared worldwide than the 30% fixed ratio allows can elect for the group ratio method instead, substituting the worldwide group's own external interest-to-EBITDA ratio for the flat 30%. That election only helps where the group's own ratio is itself above 30%; below that, the fixed ratio method already gives the larger deduction.
The interest restriction return
Once a UK group's net interest passes £2 million, one UK company has to be appointed as the reporting company, and it has to file a corporate interest restriction return within 12 months of the end of the period of account, whether or not any interest is disallowed that year. HMRC charges a fixed penalty for a late return, rising the longer it stays outstanding, and a separate penalty of up to 100% of the extra tax at stake for one that is filed but wrong.
Carrying restricted interest forward
Interest that is restricted in one year is not written off. It carries forward indefinitely and can be deducted in a later period once the group has spare capacity under the 30% or group-ratio test, for example because UK profit has grown or the loan has been partly repaid. Unused allowance works the other way round: a group with headroom in a low-profit year can carry that spare allowance forward for up to five years and set it against interest in a later, more profitable one.
A worked example
An illustration using the rules above, not a named client. A US manufacturing group lends its new UK subsidiary £8 million to build out a warehouse and buy equipment, at 7% a year, producing UK interest of £560,000. The subsidiary has no other UK group company and no other UK interest expense. £560,000 is comfortably under the £2 million de minimis, so the corporate interest restriction does not apply, no reporting company needs appointing, and no return needs filing, provided the loan itself would pass the thin capitalisation test: a UK warehouse business with a tangible asset to secure against and a trading plan to service the debt is the kind of loan an independent bank would plausibly have made at a similar size.
Three years later the same subsidiary has grown, borrowed a further £20 million from the parent at the same rate, and now carries £1.96 million of UK interest a year on its own, with two more UK subsidiaries added to the group carrying a further £300,000 between them. Aggregate UK net interest is £2.26 million, over the de minimis, so a reporting company must be appointed and a return filed. If the UK group's aggregate tax-EBITDA for the year is £6 million, the fixed ratio method allows a deduction of £1.8 million (30% of £6 million), assuming the worldwide group's external debt cap is not the binding figure. The remaining £460,000 of interest is disallowed for that year, but it carries forward and becomes deductible in a future period once UK profit has grown enough to create the spare capacity for it.
What to do this week
- Add up the interest the UK group pays, on every loan from the parent and from any other UK group company, for the current 12-month period.
- If the total is under £2 million, confirm the loan itself still prices like one a third party would have made, and stop there — no reporting company, no return.
- If it is over £2 million, work out the UK group's tax-EBITDA and compare 30% of it against the worldwide group's external interest, to see which figure caps the deduction.
- Appoint a reporting company and diary the return for 12 months after the period end, even in a year where the whole amount turns out to be deductible.
- Where a prior year carried a disallowance, check whether this year's profit has created enough spare capacity to bring some of it back.
None of this changes what the parent charges for providing finance, HR or management support, covered on the transfer pricing and intercompany page, or how a loan's interest is taxed once it leaves the UK, which the guide to getting money out of a UK subsidiary sets out. The guide to the taxes a subsidiary pays covers where this restriction sits against the corporation tax rate itself.
Common questions
Does the £2 million threshold cover one UK company or the whole UK group?
The whole UK group together. The de minimis amount in section 392 of the Taxation (International and Other Provisions) Act 2010 is tested against the aggregate net interest expense of every UK company under common control, so three subsidiaries each paying £900,000 of interest sit at £2.7 million combined and are over the threshold, even though none crosses it alone. A single UK subsidiary with no sister companies tests the figure on its own interest only. Once the combined total passes £2 million, a reporting company has to be appointed for the whole UK group, and one return covers every company in it.
Is a loan from the parent always cheaper than raising equity?
Only where the deduction survives both tests. Interest is deductible where a share subscription gives no deduction at all, so a loan usually reduces the UK tax bill more than equity funding of the same amount. That advantage falls away for whatever part of the interest fails the thin capitalisation test because the loan is bigger, or more generously priced, than an independent lender would have agreed, and falls away again, temporarily, for whatever part exceeds the corporate interest restriction in a given year. A loan sized and priced to what an outside bank would plausibly lend keeps the advantage intact.
What happens if HMRC decides the loan is bigger than a bank would have lent?
The interest on the part HMRC treats as oversized is disallowed for UK tax, and that part of the loan is treated as equity for the purpose of the calculation. The rest of the loan, up to whatever amount an independent lender would plausibly have advanced on the subsidiary's own figures, keeps its deduction. This is a separate question from the corporate interest restriction: a loan can fail the thin capitalisation test at a size far below the £2 million interest-restriction threshold, so clearing one test gives no assurance about the other.
Do we need to do anything if our UK interest is under £2 million?
Nothing beyond keeping the loan itself commercial. Below the £2 million de minimis in section 392 of TIOPA 2010, no reporting company needs appointing and no corporate interest restriction return needs filing, and the full interest deduction stands. The threshold is checked every 12-month period, so a subsidiary borrowing more as it grows needs to recheck the aggregate UK interest figure every year, since an earlier exemption does not hold automatically once new debt, or a new UK group company, pushes the total past £2 million.
What is the group ratio method and when is it worth using?
An election that replaces the flat 30% figure in the fixed ratio method with the worldwide group's own ratio of external interest to EBITDA. It produces a bigger deduction only where that ratio is itself above 30%, which happens in groups carrying more external debt worldwide than the fixed ratio assumes. A UK subsidiary of a lightly-geared group gains nothing from electing into it, because the fixed ratio method already allows the larger deduction in that case. The election is made on the interest restriction return and has to be worked out before the return is filed.
Can disallowed interest be claimed back in a later year?
Yes, with no time limit on how long it can wait. Interest disallowed by the corporate interest restriction in one period carries forward indefinitely and becomes deductible in any later period where the UK group has spare capacity under the fixed ratio or group ratio test, commonly because UK profit has grown or some of the debt has been repaid. This runs separately from the five-year limit on carrying forward unused allowance, which covers spare capacity in a low-interest year.
Does an Advance Thin Capitalisation Agreement remove the need to think about the corporate interest restriction?
No, the two cover different questions and both still apply where relevant. An Advance Thin Capitalisation Agreement fixes, in advance, the method HMRC will accept for pricing a loan's size and rate against what an independent lender would have agreed. Once that figure is settled, the corporate interest restriction is applied separately to work out how much of the resulting interest is deductible once the UK group's net interest passes £2 million a year. A subsidiary can hold an agreed thin capitalisation position and still have part of its interest carried forward under the restriction in a heavily-geared year.
Does the restriction look at the UK subsidiary's interest alone, or the whole group's?
Both, in different parts of the calculation. The £2 million de minimis and the 30% fixed ratio limit are applied to the aggregate tax-EBITDA and net interest of the UK group's own companies. The debt cap backstop, and the alternative group ratio election, bring in the worldwide group's external interest and EBITDA for comparison. A UK subsidiary cannot work out its own position from its UK figures alone once it is over the de minimis; the worldwide numbers are needed for the debt cap and group ratio tests even though the deduction itself is a UK one.
Related guides
VAT registration with no UK establishment
A UK-established business registers for VAT once its taxable turnover passes £90,000. A business with no UK establishment making taxable supplies here has no threshold at all and registers from the first one.
Do you already have a UK tax presence?
A UK taxable presence can exist, and corporation tax accrue, for two years before anything is registered. A UK taxable presence is created by what people do here, not by what has been registered.
Employer of record or your own UK company
An employer of record puts one person on a UK payroll in days without an entity. It does not give the group a UK company, and it does not settle whether the parent has a UK taxable presence.
Get a fixed quote
Tell us where the parent company is and what the UK operation has to do.
