CIR Lessons – Property development trades
CIR Lessons – Property development trades
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Capitalised interest
Where interest is capitalised into the cost of an asset in a company’s accounts, the tax treatment depends on the nature of the asset. For property development in particular, where interest is capitalised into trading stock, this may generally lead to interest deductions following the accounts and only crystallising when the stock value is released.
This will automatically create the same complications regarding the use of the CIR interest de minimis as seen for late paid interest, including if there is a short final period.
Further complications from how the interest allowance operates can, however, be quite severe if care is not taken (and if not covered by the final period’s de minimis amount).
As standard, the CIR requires that any capitalised interest is taken into account when it accrues and not when it is released to the P&L – for certain asset types this reflects the tax treatment. However, where the tax treatment actually follows the accounts, this can cause tax-interest expenses to come into later periods.
Where this happens, in the initial periods there would be no disallowances (since there would be no tax-interest expense), where there is no disallowance no ‘surplus debt cap’ is created to carry forward. In a property development scenario there would be unlikely to be profits to create an interest allowance carry forward.
In the final period when the asset is disposed of, all tax-interest expense comes into account but the debt cap will be drawn from only the interest accruing in that period. Irrespective of the profit achieved, the interest allowance would not cover the interest expenses capitalised in the earlier periods.
This treatment, however, can be addressed by the “interest allowance (alternative calculation)” election, one effect of which is to allow capitalised interest where the tax treatment follows GAAP to be taken into account when the interest ultimately crystallises. This removes the timing difference and can restore deductions. The further caveat is that this only operates so long as the election is made in the first period of the group for which interest is capitalised on the loan.
Groups have the choice of whether to expense or capitalise interest and, commercial reasons aside, there is not a single ‘right answer’ for the CIR. Expensing interest enables deductions under the de minimis in earlier periods, capitalising interest and properly applying the election can give a stronger answer for the group ratio in particular. Capitalised interest without the alternative calculation election can certainly be a ‘wrong answer’.
Development example
|
£’000 |
Expensed |
Capitalised, no election |
Capitalised with election |
|||
|---|---|---|---|---|---|---|
|
2018 |
2019 |
2018 |
2019 |
2018 |
2019 |
|
|
3rd party interest |
5,000 |
6,000 |
5,000 |
6,000 |
5,000 |
6,000 |
|
ANGIE & QNGIE |
5,000 |
6,000 |
5,000 |
6,000 |
0 |
11,000 |
|
Debt cap |
5,000 |
6,000 + 3,000 b/f |
5,000 |
6,000 |
0 |
11,000 |
|
Tax interest |
5,000 |
6,000 |
0 |
11,000 |
0 |
11,000 |
|
Group EBITDA and tax-EBITDA |
0 |
25,000 |
0 |
25,000 |
0 |
25,000 |
|
Allowance |
0 |
7,500 (fixed ratio) |
0 |
6,000 (fixed ratio) |
0 |
11,000 (group ratio) |
|
Capacity |
2,000 |
11,000 |
2,000 |
11,000 |
2,000 |
11,000 |
|
Disallowance / (reactivation) |
3,000 |
(1,500) |
0 |
5,000 |
0 |
0 |
|
Interest deduction |
2,000 |
7,500 |
0 |
6,000 |
0 |
11,000 |
For help and advice on the CIR please get in touch with andrew.stewart@bdo.co.uk or your usual BDO contact.
Corporate interest restriction - how it works