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Chapter 7

4.2 Structuring the debt/equity profile of group companies

Additional considerations for groups of companies:

 Country risk

Risk is lower if an entity borrows funds in the country where it generates its
net income. Any servicing costs for the finance can then be paid out of the
income generated without worrying about exchange rate movements.

 Type of finance provided by the parent

If debt and equity are both supplied by the parent company, the choice of
capital structure for a subsidiary has no cash implication, and is therefore
independent of the decision regarding the appropriate group capital
structure.

 Tax issues

Within a group of companies, it makes sense to maximise borrowings in
regimes with the highest tax rate, to increase the amount of tax relief
available. Tax relief can be limited though, by transfer pricing issues and by
thin capitalisation rules.

 Transfer pricing

If one company in a group has borrowed money from another company in a
group, an adjustment will be necessary if it is deemed that the interest rate
charged is not set at a market rate.

 Thin capitalisation rules

The thin capitalisation rules aim to stop companies from getting excessive
tax relief on interest if they have entered into a borrowing with a related
party that exceeds the amount a third party lender would be prepared to
lend.

A debt : equity ratio of greater than 50 : 50, or interest cover lower than 3
indicates thin capitalisation.

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