Please note: the tax proposals described below may not now take effect from the date stated – read more on the tax changes dropped from Finance Bill 2017 as a result of the snap General Election.
The UK’s new corporate interest restriction takes effect from 1 April 2017. Companies with rolled up interest carried forward under the ‘late paid interest’ rules should carefully consider payment timing.
Outline of the restriction rule
The rule will apply to a ‘group’ (based on the requirement to prepare consolidated accounts) headed by a corporate entity. It will allow the higher of:
- De Minimis: £2m net interest
- Fixed Ratio: 30% of ‘tax-EBITDA’
- Group Ratio: Group’s ratio of third party interest to EBITDA, up to 100%.
Interest under the Fixed Ratio test will be limited to the overall net interest expense of the ‘group’.
The Group Ratio operates on interest from third parties, and is capped at the total net interest expense of the group excluding related party interest amounts.
Depending on a company’s year-end, the corporate interest restriction may apply from part-way through a period.
This results in the need to calculate a notional split period to apply the new rule to the period after 1 April.
The starting point for allocating amounts to the split periods is a time apportionment, which will make sense for many profit and interest items. Where time apportionment would not give a just and reasonable basis, a just and reasonable apportionment is used.
This is likely to be relevant for late paid interest, as well as any significant one-off items of income or expense (such as break costs on derivatives), which may be fairly allocable entirely to a specific date. (No guidance has yet been issued in respect of the new law and we therefore cannot confirm that HMRC will agree this is a just and reasonable allocation in this respect).
Impact on late paid interest
The corporate interest restriction will potentially cause difficulty for groups with accrued but unpaid interest that falls within the late paid interest rules.
The payment of interest may crystallise relatively high interest deductions in a year, eg if interest from several periods is paid at once, making the group more likely to exceed 30% of tax-EBITDA. (Payment for these purposes includes interest that is cash paid or satisfied through the issue of payment in kind notes / funding bonds).
Furthermore a cap based on accounts interest will apply potentially further restricting the amounts deductible.
These factors are most relevant to interest accruing before 1 April 2017 due to carry forward allowances. Some groups may find that rolled-up interest needs to be paid before 1 April 2017 (or within 12 months of the end of the period in which it accrued) to access deductions.
Following 1 April, interest payments for some groups could benefit from planning to maximise use of the de minimis allowance.
Loss relief rules
New loss relief rules will also apply from 1 April 2017, again with split period relief. These will introduce both greater flexibility for the use of losses arising after 1 April, no-longer requiring streaming, but also where a group’s taxable profits exceed £5m, a restriction of relief so that only 50% of that excess can be sheltered by losses brought forward.
These new loss rules may need to be taken into account when considering whether to pay interest before or after 1 April 2017.
Illustration of application
The following examples assume that the group in question has £20m of interest accrued and unpaid from periods ending 31 December 2016 or before:
As shown in the examples, not all companies with late paid interest will be affected equally by the introduction of the corporate interest restriction. It is vital to understanding the dynamics of the various new rules effective from April 2017 before making decisions regarding payment of interest.
As with any payment of interest, there will potentially be other factors to take into account:
- Valuation of payment in kind notes
- Any withholding tax applying on the interest payment could affect the net tax impact of payments
- Hybrid mismatch rules apply from 1 January 2017, potentially disallowing all deductions where hybrid instruments or entities are involved in the structure.
Finance Bill legislation
The Finance Bill 2017 published on 20 March 2017 confirmed the above analysis will be relevant.
We are hopeful certain amendments will be made before the legislation receives Royal Assent but we recommend companies with late paid interest act swiftly.
Your next steps
If your group has interest restricted under late paid interest rules, carefully consider whether payments are needed ahead of 1 April 2017. BDO is on-hand to provide guidance, support and advise to you.
Corporate interest restriction – the basics
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Corporate interest restriction: Public Benefit Infrastructure Exemption
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