On 12 May 2016, the Government issued a second consultation document on the limitation on interest deductions that will come into effect from April 2017. This follows the release of the OECD recommendations on corporate interest deductibility in October 2015 (see October 2015 edition of Business Edge) and an initial consultation (summarised in the January 2016 edition of Business Edge).
The consultation document confirms a number of announcements made in the Budget. The main rule can be summarised as follows:
- Figures will be aggregated for all UK members of a ‘group’, any disallowance
- Interest is calculated including capitalised interest and after other limitations such as transfer pricing, anti-hybrid and unallowable purpose tests. Foreign exchange movements will be excluded
- Tax-EBITDA is PCTCT before interest, capital allowances, IFAs and capital losses (not gains)
- A de minimis of £2m in total will be allowed for the UK group members
- A fixed ratio of 30%, or if higher group ratio, of ‘tax-EBITDA’ will be allowed
- The ratio test, but not de minimis amount, will be subject to a cap based on overall net group interest expense (replacing the Worldwide Debt Cap)
- Interest disallowed under this rule can be allocated at will to specific companies
- Disallowed interest will be carried forward indefinitely, to be allowed in years when there is sufficient capacity
- Excess capacity may be carried forward up to three years within a specific company
- Interest deductions from before 1 April 2017 (eg under late paid interest) will not be affected.
Detail and implementation
The consultation document covers a wide range of features of the new rule and poses 46 questions across these areas. We have highlighted several areas below that will be most commonly applicable.
Related party interest
The group ratio rule will be restricted by excluding related party interest amounts from the group’s total qualifying interest amount. This is aimed at private equity investments and owner-managed businesses. The Government does not intend to capture genuine lenders, even where a small equity stake is held, but the detail of how these objectives will be reconciled is yet to be seen ( question 20 ).
Conversely, related party interest will not be excluded from the broad interest cap, keeping the effect in line with the Worldwide Debt Cap.
Challenge to the group ratio
The purpose of the group ratio is to ensure that a fair amount of a group’s genuine third party interest expense is brought into account, for example giving highly leveraged infrastructure businesses a greater interest capacity.
The nature of a group ratio becomes difficult if there are loss-makers within a group as the consolidated EBITDA position could be lower than the profit relied on by lenders, or indeed the UK group members. This leads to a practical cap on the group ratio based on group-wide net interest (duplicating the cap, but this time excluding related party interest).
The Government, however, is still concerned this may be too generous and is seeking to put further limits on the group ratio ( question 15 ), this could be a genuine concern to businesses with high leverage.
The definition of ‘group’ is based on an ultimate parent company that would need to consolidate subsidiaries on a line-by-line basis, excluding portfolio investments, associates and joint ventures. This is in line with recent rules on tax strategy reporting and country-by-country reporting.
As under the worldwide debt cap rules, collective investment vehicles will be excluded from being parent of a worldwide group,
Double tax relief
There is no discussion or proposal to allow tax relief to lenders where deductions are disallowed.
We recommend all UK companies undertake a review of their interest position to identify any potential exposure to the new rule. Engagement in the consultation also is highly recommended, directly, through an industry body or through BDO or another adviser, especially for those taxpayers:
- Where the proposed public benefit exemption could potentially be relevant – this definition is not finalised
- Involved in real estate
- That are highly leveraged and could be affected by the restriction to the group ratio
- In the banking or insurance sector
Read the second consultation document (the consultation closes on 4 August 2016).