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CIR Lessons – Calculation complexities and the group ratio

03 August 2020

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CIR Calculations

Unexpected difficulties in calculating the corporate interest restriction can arise through using tools, in particular, big tax computation software that is often relied upon by advisers. These tools may have carefully implemented CIR calculations in ways which cleverly bring together figures from tax computations but understanding the process is important rather than trusting them as a ‘black box’ solution.

An example we have encountered (and learned to be careful with!) is foreign exchange movements. These are, in the first instance, appropriately treated as loan relationship items but for the purposes of the CIR must be excluded from tax-interest.

The manner by which such items are excluded becomes important since the legislation calculates tax-EBITDA on a bottom-up basis, ie starting with profits and losses arising in the period and then adding back items such as capital allowances and tax-interest. If an item no longer falls into tax-interest then it will, unless carved out separately, fall into tax-EBITDA.

Especially where the tax software that calculates tax-EBITDA in an additive fashion, debits and credits adjusted out of tax-interest can be easily missed if not adjusted correctly.

Wider checks to make sure that components of tax-interest and the like are correctly identified, for instance that trade related loan relationship credits and debits are separated from trading income, but these are at least obvious to deal with.

Group ratio – potentially helpful, but complex and no panacea

The principle of the group ratio is relatively clear and well received by taxpayers, ie this approach seeks to allow a deduction for interest on a group’s third party debt where UK borrowing is proportionate to the worldwide position.

However, the small logical step, especially for UK-only groups, to “we will get a full deduction on third party interest” is all too easy to make, potentially leading to confusion and/or incorrect filings.

For a UK-only group, unexpected disallowances can result where taxable profit is lower than accounting profit. Fortunately, this is not the default case since most tax rules seek to limit deductions, such as disallowing client entertaining expenses, but is certainly possible.

Chargeable gains calculations give some intrinsic differences between tax and accounts calculations, such as indexation, although an irrevocable election enables the main factors to be aligned by applying capital gains principles to the accounts. This is relatively practical for UK-only groups (where tax principles will need to be applied anyway) but harder for international groups.

A significant divergence is where the substantial shareholdings exemption applies as the chargeable gains election does not bring that exemption into effect for the CIR calculation, leaving tax-EBITDA (with the disposal exempt) potentially significantly lower than group-EBITDA.

If using the group ratio, HMRC will expect to see full calculations and if an abbreviated return is used, the full calculations are likely to be requested from the group.

The group ratio allowance can also not exceed tax-EBITDA, and so can also cause disallowances for companies with limited profit irrespective of how closely tax and accounts figures might match.

Finally, it’s important to remember the group ratio is not automatic and applies by election only – a return (abbreviated or full) is, therefore, required to use the group ratio. Simply not restricting interest in tax computations on the assumption the group ratio would have shown it all as allowable, without undertaking calculations or submitting a return, is to be strongly advised against.

For help and advice on the CIR please get in touch with [email protected] or your usual BDO contact.

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