thin capitalisation
Thin capitalisation is when a company funds itself with far more debt than equity, often to a related party, so interest payments shrink its taxable profit.
In plain English
Why would a profitable looking company somehow pay almost no tax? That question sits behind thin capitalisation, and once you see the trick, you will spot it everywhere.
Here is the setup. A parent company abroad lends money to its Nigerian subsidiary instead of investing it as share capital. The subsidiary now pays interest on that loan every year, and interest is a deductible expense, so it eats into the profit that would otherwise be taxed. Meanwhile the parent calmly collects the interest, often taxed at a lower rate elsewhere or not at all. The company looks busy and productive on paper, but a huge chunk of its funding is debt dressed up to look like normal business borrowing, when really it is a tax planning device.
Nigeria's tax law now sets a limit on this. Under the Finance Act rules, a Nigerian company connected to a foreign parent can only deduct interest on related party debt up to 30% of its earnings before interest, tax, depreciation and amortisation. Anything borrowed beyond that ratio, the excess interest is disallowed as a deduction, so FIRS taxes the profit as if that extra debt never happened.
Think of a Lagos manufacturing firm owned by a company in Dubai. The Dubai parent could inject ₦500 million as equity, or it could lend the same ₦500 million at 15% interest. Equity brings no automatic deduction. The loan brings an annual interest bill of ₦75 million that reduces taxable profit, unless the thin capitalisation rule caps how much of that interest actually counts.
For a Nigerian in London running a UK subsidiary funded heavily by a Nigerian holding company, the same logic applies under HMRC's own thin capitalisation and transfer pricing rules. Tax authorities everywhere have learned to ask the same question: is this debt real, or is it equity in a costume?
A Lagos subsidiary earns ₦200 million EBITDA and pays ₦90 million interest to its foreign parent on an intercompany loan. The 30% cap allows only ₦60 million as deductible interest, so the remaining ₦30 million is added back to taxable profit, and the company pays tax on it as though the loan never existed.
Questions people ask
Is thin capitalisation illegal?
No, borrowing from a related company is legal. What gets restricted is how much of the interest on that debt you can deduct for tax purposes once it crosses the set ratio.
Does thin capitalisation only apply to foreign owned companies?
It mainly targets related party lending, which is most common between a Nigerian subsidiary and its foreign parent, but the rule applies to any connected party arrangement structured to shift profit through interest.
How does a company know if it has breached the rule?
It compares its related party interest expense to 30% of its EBITDA for the year. Anything above that threshold gets disallowed as a deduction, and a tax audit will usually catch it if the company has not already adjusted its own filing.
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