Corporate interest restriction - how it works

CIR issues and considerations

There are a number of potential issues and considerations in how to apply the CIR rules. You can explore these below.

CIR; the basic rules

The rules are structured to restrict UK net interest deductions (expense less income) to the higher of:

• De minimis: £2m per annum
• Fixed Ratio: 30% of ‘tax-EBITDA’
• Group Ratio: Group’s ratio of interest to EBITDA

Interest under the Fixed Ratio and Group Ratio tests will be limited to the overall interest of the ‘group’, subject to certain adjustments. The rule applies to a ‘group’ (based on the requirement to prepare consolidated accounts) headed by a corporate entity.

UK tax-adjusted figures are aggregated before applying the tests (i.e. there is a single £2m de minimis per group), before allocating any disallowance to companies. The flow-chart below illustrates how these measures will apply.

Identifying the group for CIR purposes

The Corporate Interest Restriction (CIR) rules operate on a group basis, with tax figures aggregated from all UK members of the group, and consolidated accounts figures required for calculations. It is  vital to know what the group comprises of and to access the consolidated accounts. There are plenty of potential issues in the identification process.

The group is defined as an ultimate parent company and all its subsidiaries, excluding any subsidiaries that would be excluded from consolidation under the fair value accounting rules in IFRS 10 for investment entities. If you not familiar with the details of IFRS 10, there is a risk that important points may be lost.

IFRS 10 – Investment entities

Start by assuming this set of accounting rules does not apply unless it can be shown otherwise – companies reporting on a fair value basis are more likely to have considered these points in detail.

The purpose of the investment entity accounting rules is to allow funds to report to their investors on a practical basis that makes sense in the circumstances, i.e. showing what the value of investments is, rather than amalgamating underlying trading results.

If in you are in doubt about IFRS 10 and where a decision makes a material difference in the CIR calculations, you should consult technical specialists. We have summarised the key tests, which include indicators rather than solely fixed rules.

• Multiple investors – An investment entity will generally serve multiple investors (which can be investing through a feeder vehicle) that will usually not be related parties of the entity
• Multiple investments – An investment entity will generally have more than one investment
• Investment purpose – An investment entity must have a purpose of investing for capital gain and or income for its investors
• Fair value reporting – The entity should in practice report the fair value of its investments to its investors.

A lack of consolidated accounts does not stop a company heading a multi-company group under the CIR rules. Consolidation might not be undertaken for a range of reasons, such as the small size of the group or simply that it is not required under local GAAP. The investment entity exemption under IFRS 10 is the only relevant exclusion relevant and is not very common. A prudent starting point is to assume all subsidiaries will be part of the same group.

Larger structures

A UK company may be part of a much larger group or disparate investment structure, such as a sovereign wealth fund, without visibility of the full picture. The UK financial and/or tax team will know the immediate structure and the entities they trade with, but might never previously had needed to know about all sister companies or the accounting policies applied by the company’s parent companies.

There is no magic bullet for resolving these cases. The UK company will be reliant on those further up the chain understanding the rules and sharing knowledge. It is important to engage in early discussions and to carefully explain what you need to know. You may have to provide guidance on the meaning of terms, for instance the importance of the debt cap and key criteria for fair value accounting under IFRS 10.

If you cannot obtain the information you need, there are limited routes you can take to resolve the matter. For instance, the ultimate owner of the company should be identifiable – with anti-money laundering rules making this essential for advisers to know as well - which could allow you to use company information databases to identify other companies with the same ultimate owners. Other UK companies identified could be contacted to ask their view, but this will not give you a full answer. Ultimately it may be necessary to estimate what the group consists of and provide a clear disclosure.

Accounting for unconsolidated groups

In cases where there is a CIR group, but the ultimate parent does not actually prepare consolidated accounts, it will be necessary to assess the relevant figures for the CIR as if those accounts had been prepared.

This is, generally, less onerous than drawing up a full set of consolidated accounts. If using the fixed ratio, then only the Adjusted Net Group Interest Expense (ANGIE) is needed to be used in the debt cap calculation.

Preparing a consolidated ANGIE figure is as simple as aggregating the net interest, albeit considering the various adjustments required, for each entity in the group. This can be simple if adding on only one or two parent companies.

In complex cases, it might be possible to show that while you do not have the exact ANGIE figure, it is certainly much larger than the interest allowance. This should be seen as ‘good enough’, with acknowledgement that the use of estimated figures may not be required in such cases.

Tests for the group ratio are, of course, more complex with more accurate consolidation required to identify related party interest expenses and Group EBITDA. If these figures cannot be calculated, the UK group should not use the group ratio in its CIR calculations.

Take care with CIR group changes

Having established what the group is, it is important to be aware when it changes. If the ultimate parent company to a group is acquired by another company, this will generally cause the first CIR group to cease, and the companies to now fall into another group. Results from UK companies in the first group will need to be split between several CIR groups and periods, unless the acquisition was at the year-end.

Disallowances and carry forwards

If a CIR group has net tax interest expense greater than its interest capacity in a period, the excess must be disallowed, with disallowances allocated to specific companies.

The default allocation of disallowances is pro-rata between those members of the CIR group with net tax interest expense. For example, if in a three-company CIR group: Company A has net interest expense of £2m, Company B has net interest expense of £2m and Company C had net interest income of £1m, any disallowance would be split 50:50 between Company A and Company B.

The allocation of disallowances may be overridden in a CIR return to allocate disallowance at will, although no company can disallow more than its net interest expense.

Once allocated a disallowance, companies should track the amounts disallowed. In future periods, if the CIR group has an interest allowance higher than its net interest expense for that later period, it may ‘reactivate’ interest by allocating an amount of the surplus to companies with brought forward disallowed amounts. Interest reactivated will be treated as the original expense brought into account in the relevant later period.

Disallowed interest will be carried forward indefinitely by companies unless they cease their trade or investment activity, subject to the potential impact of wider change in ownership rules.

Other carry forward amounts also apply under the CIR rules.

The Fixed Ratio and Group Ratio calculations for interest allowances are limited by a ‘debt cap’ figure, which takes into account both current year figures from the group consolidated accounts, and any brought forward ‘excess debt cap’. The excess debt cap can only increase in periods where there is a restriction of interest and is needed to enable interest reactivations to work in some cases.

If interest allowances in a period exceed net tax interest expenses, the surplus can be carried forward for up to five years. The brought forward interest allowances can increase interest allowances in subsequent periods and are used up oldest first.

Surplus interest allowances can only be carried forward if the CIR group files a CIR return.

Both surplus interest allowances and excess debt cap amounts are attributed of the CIR group and any change to the identity of the CIR group, through a new holding company, may eliminate any such figures.

How does the CIR interact with other rules?

The CIR rule applies after other tax adjustments. The starting position for calculating tax-EBITDA is a company’s Profit Chargeable to Corporation Tax after almost all tax adjustments – the main exception being R&D relief. Interest, capital allowances and intangible fixed asset allowances are added back.

The net interest expense figure is net of interest income and calculated after other rules such as transfer pricing including thin capitalisation, and the unallowable purpose and anti-hybrid rules.

The potential for CIR limitations may reduce the immediate net tax impact of these other rules in some cases, but the potential for interest disallowed under the CIR to be carried forward and potentially reactivated means separate testing remains important.

Late paid interest

The late paid interest rules, unhelpfully, apply before the CIR and in certain cases where interest is not paid within 12 months of the period end can delay any deduction to the period when interest is paid. The interaction of late paid interest rules with two aspects of the corporate interest restriction will potentially cause difficulty for groups with accrued but unpaid interest that falls within the late paid interest rules:

• High interest deductions in a year, e.g. if interest from several periods is paid* at once, will be more likely to exceed the de minimis and 30% of tax-EBITDA
• The cap at the group’s interest per accounts could cause a restriction on late paid interest if all the group’s interest is otherwise tax deductible in the UK

*Payment for these purposes includes interest that is cash paid or satisfied through the issue of payment in kind notes / funding bonds

Carrying forward the allowance

The carry-forward rules for interest allowances prevent this being unfair. If an amount of late paid interest from year one would have been covered by the interest allowance then that surplus allowance will be carried forward to use in the year when the interest expense ultimately crystallises. In this way, the total interest allowance over the period will be the same and the total amount of deductions under that allowance can be the same. However, the carry forward allowance can only assist for up to five years and will not help in respect of any interest arising before the CIR rules took effect in April 2017.

Impact of the £2m de minimis

For smaller groups, a more significant point is that the de minimis amount is only taken into account for the interest capacity and not the interest allowance: this means that no surplus of the £2m annual amount able to be carried forward. Where a group that has annual interest expense below £2m and considers itself to be ‘safe’, it could find an unpleasant surprise if late paid interest causes the de minimis to be exceeded in a specific period.

For all private equity backed groups in particular, great care needs to be taken on exit. If the entire group is acquired, the original CIR group ends at that time – which causes the relevant period to end. If late paid interest is ultimately paid after the acquisition, the expense should be allocated to the new group’s CIR calculation. This separates the amount from any brought forward interest allowances, which would be extinguished with the old CIR group.

Whether the interest crystallises before or after the sale of the group, the length of the period will affect the de minimis. A short period can come down to days or weeks (usually for amounts before sale) or a long period could give a higher de minimis up to £3m (note that a long period cannot exceed 18 months for CIR purposes).

IFRS16 leasing

The CIR takes into account the financing expense on finance leases as if it was interest, giving a potentially significant impact on groups when adopting these rules. The approach taken caused companies with ‘right to use’ leases (i.e. ‘on balance sheet’ items) to assess whether these would have been classified as finance leases or operating leases, with only the finance lease element brought in.

This provided consistency with the rules and for companies operating on other accounting standards, such as FRS 102. The drawback of the treatment, like much with the CIR, is complexity as this reclassification was required on the group’s consolidated accounts (where prepared under IFRS or a similar standard incorporating the new lease treatment). Where UK companies form only a small part of a large international group, this was seen as an onerous requirement.

Reporting your corporate interest restriction

The CIR has a reporting regime that sits alongside companies’ CT600 filing obligations. The principle behind this is that the CIR operates at a group level even where a ‘group’ happens to consist of a single company.

It is important to note that filing a CIR return is separate from applying the CIR rules – those will remain applicable even if no filing is required. No company has an automatic obligation to prepare or file a CIR return, this only comes about if the group elects a reporting company or if HMRC appoints one for the group.

Two very different time limits exist for these different routes, and it is notable that it is only possible for a group to appoint a reporting company within 12 months of the end of the period of account. HMRC has a longer window, up to four years from the end of the period (or longer if relevant tax computations can be altered).

When should a group elect?

All groups should first consider if they need to file a CIR return. Filing a CIR return is necessary in order to:

• Carry forward interest allowances
• Make certain elections under the CIR rules
• Allocate any interest disallowance to specific companies
• Allocate interest reactivations (which will not be relevant in the first period).

Where applicable, an abbreviated return gives a simple filing option that keeps flexibility to extend to a full return if beneficial.

The CIR de minimis interest rules provides an important threshold when considering what approach to take. If the total net tax-interest expense across the UK companies in the group (i.e. tax deductible interest less taxable interest income) is below the £2m annual de minimis and won’t exceed this level in the next five years, there is unlikely to be any benefit in filing a return. In other cases, it is likely to be worth filing at least an abbreviated return.

What are the filing requirements?

Once a reporting company has been appointed, it will be obliged to notify the other group members of its status and to prepare a CIR return (until such time as the appointment is revoked by the group). The return will need be filed on the later of:

• 12 months from the end of the period of account (but see below for changes to groups)
• 3 months from the appointment of the reporting company (primarily where HMRC makes an appointment)

If a group has no interest restriction in a period, the reporting company can file an abbreviated return, which omits the detail of calculations but also does not allow interest reactivation or allowance carry forwards (unless/until replaced with a full return).

Returns must be filed through authorised software or through HMRC’s portal.

Abbreviated returns

An abbreviated return may only be made if the group is not subject to a restriction of interest. It must contain:

• The name (and UTR if relevant) of the ultimate parent company of the group
• A list of the names and UTRs of all companies in the group
• A statement that there is no disallowance
• A statement that the return is accurate.

Full returns

A full return must contain the same detail as abbreviated return, plus:

• A statement of calculations, including details of tax-interest and tax-EBITDA figures for all companies subject to UK tax, relevant accounts-based figures and the interest allowance and interest capacity
• Statement as to whether there is a disallowance and if so detail on how it is allocated
• Statement as to whether there is a reactivation of interest and if so detail on how it is allocated.

Appointing of a reporting company

Once you (or HMRC) have decided that returns are appropriate, a ‘reporting company’ needs to be appointed by a majority of eligible companies in the group (i.e. those in the charge to UK corporation tax and not dormant throughout the period).

This must generally be within 12 months of the period end for which a return is appropriate. If you have missed the deadline, it is possible to ask HMRC to appoint a company for the group.  HMRC has issued several updates to its policies in this area, with guidance currently showing a very restricted set of circumstances in which HMRC will consider such appointments.

As noted above for filing returns, the appointment of a reporting company must be made through approved software or through HMRC’s online portal.

The reporting company must notify the eligible companies (and the ultimate parent company) that it has been appointed. The reporting company will be granted statutory powers to require the relevant data to complete a return from other UK group companies.

It is worth remembering that if some group members, or companies that have left the group during the period, do not wish to be bound by the reporting company, it is possible for them to elect to be ‘non-consenting companies’. This status limits the potential allocations of disallowances to the affected companies and may be relevant in groups with diverse management teams or minority shareholders.

An appointment may be revoked by a majority of eligible companies.

Potential pitfalls

Areas that could catch groups out include:

• A group is defined based on the holding company – therefore a company can be part of several groups during an accounting period and if a new holding company is inserted it is likely that an entirely new group would be formed. As the reporting deadlines usually run from the date first group ‘ends’, it is important that appointment of reporting companies should be considered for each relevant ‘group’ during the accounting period.
• Final figures might not be considered across the group until it is too late to appoint a reporting company for the period, especially if significant tax adjustments could be required.
• Certain delayed interest amounts, such as late paid interest or interest capitalised into the cost of stock, may make a return or elections beneficial when there would not appear to be disallowances.
• The group may have a period distinct from some or all UK group companies, complicating calculations (with CIR deadlines based on the group’s period), and multiple dates may need to be considered where there are multiple groups.
• The £2m annual de minimis is pro-rated for short periods.

If there is any doubt over the benefit or importance of a CIR return, it is prudent to appoint a reporting company for the group within the deadline.

Tax elections possible under the CIR rules

There are many different tax elections that a group or company may wish or need to make to manage the impact of the CIR on the business.

The table below provides a brief summary of each. Please get in touch if you would like specific advice on whether or not making an election would benefit your business.