Financing & treasury
Thin capitalisation
Thin capitalisation occurs when a company is funded with a disproportionately high level of debt relative to equity, often through intercompany loans from group entities, allowing interest deductions to erode the local tax base while shifting profit to jurisdictions where the lender is taxed more favourably on the resulting.
Many jurisdictions apply fixed debt-to-equity ratios, interest coverage tests, or earnings-based interest limitation rules to cap deductible interest, and even where no bright-line ratio exists, tax authorities can challenge whether the debt level itself would ever be extended by an unrelated, independent lender on comparable.
Defending an intercompany financing structure against thin capitalisation challenges requires a genuine debt capacity analysis showing the borrower could service the debt from its own cash flows, alongside market evidence that comparable independent companies in the same industry operate with similar leverage and gearing levels.
In practice
What matters when applying thin capitalisation
- Check local debt-to-equity or interest limitation rules
- Perform a genuine debt capacity analysis
- Benchmark leverage against comparable independent companies
- Ensure interest could realistically be serviced from cash flow
- Document the commercial rationale for the funding structure
Frequently asked
Common questions
What triggers thin capitalisation challenges?+
Debt levels disproportionate to a company's equity and cash-generating capacity, often flagged when fixed ratio tests, interest coverage limits, or earnings-based rules are exceeded in the relevant jurisdiction.
How can a group defend its funding structure?+
With a debt capacity analysis showing the borrower can genuinely service the debt from its own cash flows, supported by leverage benchmarks from comparable independent companies in the same sector.
See how the tooling handles this in practice
Our transfer pricing tools calculate intercompany charges, benchmark financing and reconcile the intercompany ledger from your own data. Book a short walkthrough and we will show the workflow on a scenario that matches your group structure, rather than a generic demo dataset.