CIR Lessons – Calculation complexities and the group ratio
CIR Lessons – Calculation complexities and the group ratio
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CIR Calculations
Unexpected difficulties in calculating the Corporate Interest Restriction (CIR) can arise through using tools such as big tax computation software. These tools may have carefully implemented CIR calculations to bring together figures from tax computations but understanding the process is absolutely vital and these tools cannot be trusted 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.
How such items are excluded becomes important because the legislation calculates tax-EBITDA on a bottom-up basis i.e. 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 calculates tax-EBITDA in an additive fashion, debits and credits adjusted out of tax-interest can be easily missed if not adjusted correctly.
You will need to make wider checks to make sure that components of tax-interest are correctly identified. For instance that trade related loan relationship credits and debits are separated from trading income. Some checks are more obvious than others.
Group ratio – potentially helpful but complex
The principle of the group ratio is relatively clear and well received by taxpayers. 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 and can potentially lead 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 it is certainly possible.
Chargeable gains calculations create 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 be applied anyway, but harder for international groups.
A significant divergence can occur where the substantial shareholdings exemption applies, because 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 you are 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.
An important step in applying the group ratio is to understand whether a lender is a ‘related party’ for the purposes of the CIR. This will include any lender with at least a 25% interest in the group (including 25% of value on exit), and situations where a shareholder has provided guarantees to the lender. There are some situations where a related party will be deemed to be non-related in respect of a given loan, and some situations where non-related parties will be treated as related – so it’s important to take care before assuming the rule is helpful.
Finally, it’s important to remember the group ratio is not automatic and applies by election only – a return is, therefore, required to use the group ratio. We strongly discourage 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.
For help and advice on the CIR please get in touch with andrew.stewart@bdo.co.uk or your usual BDO contact.