Corporate interest deductions – new restrictions

New restrictions for corporate interest deductions take effect from 1 April 2017 – are you ready?

The UK government has published the remaining Draft legislation: corporate interest restriction to implement the new restrictions for corporate interest deductions arising from Action 4 of the Organisation for Economic Co-operation and Development’s (OECDs) base erosion and profit shifting (BEPS) project. The rules take effect from 1 April 2017, including in respect of accounting periods straddling this date. They are expected to result in a significant reduction to the tax relief that UK businesses can claim for corporate interest expense – the government expects to raise additional tax revenues totalling nearly £4 billion over the course of this parliament.

The legislation is lengthy, running to over 130 pages, very complex and there are many areas of uncertainty that are likely to arise in interpreting some of the applicable definitions. There are also some notifications and elections that may need to be made. With little time left before these new rules come into effect, businesses should consider their potential impact and any practicable refinancing or restructuring opportunities at the earliest opportunity.

An overview of the new rules

The new rules apply on a group basis rather than on a company-by-company basis. All interest, including amounts payable to third parties and other similar financing costs, are covered by the new rules but there is a £2 million de minimis level of net interest expense, below which a group will not suffer a restriction.

The basic approach of the new rules is to restrict tax deductions for UK net interest expense where it exceeds the interest allowance of the group calculated by reference to:

  • 30% of the taxable earnings before interest, taxes, depreciation and amortisation (EBITDA) in the UK, known as the Fixed Ratio Rule (FRR) or
  • a proportionate share of the group’s net interest expense, equal to UK taxable EBITDA multiplied by the ratio of worldwide net interest expense to worldwide EBITDA, known as the Group Ratio Rule (GRR)

Other tax rules that can restrict interest relief such as the transfer pricing, unallowable purpose, hybrid and other mismatches and distribution provisions will be applied in priority to the new rules. The existing worldwide debt cap provisions will be repealed, subject to the retention of a modified debt cap rule to prevent groups with little third party interest expense claiming excessive deductions in the UK. The modified debt cap requires that a group’s net UK interest deductions cannot exceed the worldwide net third party interest expense (as noted above, a group is entitled to at least £2 million). Any restricted net interest expense can be carried forward for relief in later periods and any spare interest allowance can be carried forward for up to five years.

There are public infrastructure rules to protect investments in infrastructure that has a public benefit attached.

Net interest expense includes amounts ordinarily deductible or taxable for UK tax purposes arising from loan relationships, certain derivative contracts or financing costs implicit in amounts payable under arrangements such as finance leases, debt factoring and service concession arrangements accounted for as financial assets or liabilities or amounts received for providing a guarantee. Broadly speaking, amounts relating to exchange gains or losses or impairment provisions or impairment reversals are excluded.

The rules contain a targeted anti-avoidance provision to counteract any tax advantage that arises from “arrangements” where the main purpose is to enable a tax advantage that is derived, in whole or in part, from the interest restriction rules.

The above is a very high level overview of the principle features of the new rules. The legislation requires careful consideration by affected businesses.

How you should prepare for the new rules

Businesses should model the application of the new rules at the earliest opportunity in order to ascertain their potential impact and assess what actions can or should be taken.

Businesses should also be aware of the need to appoint a reporting company and notify HMRC within six months of the applicable accounting period end.

In order to fully understand the impact of the rules, it may be necessary to undertake detailed calculations and consider broader options such as the use of alternative accounting practices. We can help businesses to model the impact and consider the benefit of making available elections or taking other appropriate actions, including restructuring or refinancing where practicable. For further information, please contact Elizabeth Hughes, David Hill or your usual Grant Thornton tax specialist.