Knowing how and when to apply the corporate interest restriction rules is a challenge for many businesses. Mandipa Soni shares what we’ve learnt in five years of handling the corporate interest restriction regime.
Given the current economic climate, we're seeing more businesses take on increased financing and debt facilities. The cost of debt can be quite high, not least due to restrictions on corporate tax relief for interest costs. The corporate interest restriction (CIR) regime was introduced five years ago but knowing how and when to apply the rules remains a challenge for many finance teams. Here are the most common issues and key learnings we've found when supporting clients impacted by CIR – as well as some opportunities.
The corporate interest restriction (CIR) regime was introduced in April 2017 – as an overlay to existing UK corporation tax legislation applicable to financing transactions, and in response to the OECD’s recommendations on interest limitations for corporation tax purposes.
Prior to the CIR rules coming in, UK groups were already navigating a number of tax anti-avoidance provisions governing the deductibility of interest costs, including the unallowable purpose rules, thin capitalisation and the anti-hybrid rules (also introduced in 2017).
The CIR rules introduced a further interest restriction based on a fixed ratio rule, which limited interest deductions to 30% of earnings before interest, tax, depreciation, and amortisation (EBITDA), but subject to a de minimis limit of £2 million. The rules allow a higher percentage to be used where the worldwide group’s interest ratio exceeds the 30% limit.
They apply on a group basis and can limit all interest costs including amounts that would otherwise be deductible on third-party and arm’s-length-related party loans.
In addition, the CIR rules contain a debt cap rule that limits borrowings in the UK group to the external borrowings of the worldwide group. Any restricted interest can, in principle, be carried forward and ‘reactivated’ in future years when there is capacity, and unused interest capacity can be carried forward for five years.
Five years on, the rules continue to pose significant challenges for many groups, including:
determining the worldwide group for CIR purposes
obtaining the relevant data to prepare the calculations
making decisions in relation to elections (a number of which are irrevocable) to apply alternative methods for the calculations
understanding the administrative requirements and compliance obligations
Lesson 1: Don't miss the potential of carry forward
In most cases, groups will need to appoint a reporting company which is required to submit an interest restriction return (IRR) for each period of account, calculating the potential restriction and allocating it across UK group companies. Groups that do not have a restriction (or fall below the £2million limit) are not required to nominate a reporting company or submit an IRR.
The CIR position may give rise to excess interest allowance in a given year, which has the potential to be carried forward and used against future restrictions in the next five years. Often this is driven by significant growth or a change in debt profile and could arise where the interest costs fall below the CIR capacity for the period. In this case, it may be beneficial for the group to elect to submit an abbreviated return in order to bank the interest allowance for future periods – without having to provide full CIR calculations.
Abbreviated returns may be replaced with full IRRs in the next five years in order to claim the brought forward interest allowance. This may be relevant where economic circumstances have resulted in a restriction. It may also benefit groups that hadn’t previously thought they would need the allowance.
Companies should now consider and review their first corporate interest restriction period of account to ensure that any unused interest allowance arising in the first year of the CIR rules being in point is used where possible – ahead of expiry. For example, interest allowance arising in the year ended 31 December 2017, will need to be used in the year ended 31 December 2022. Companies may need to consider the derecognition of any associated deferred tax assets.
Lesson 2: Manage interest restrictions and reactivations carefully
Where a group has calculated a potential restriction under the CIR rules, it will need to consider how this disallowance is allocated across UK group companies. It's also possible that historic restrictions could be ‘reactivated’ under the CIR rules – an automatic relief, applying where there is sufficient interest capacity in a future year. These rules may be particularly relevant in the current climate, where COVID-19 has resulted in short-term fluctuations or disallowances as a result of a fall in EBITDA across a group.
Managing interest restrictions and reactivations across a UK group should be carefully reviewed. A key consideration here includes how the restrictions and reliefs interact with the changes to the corporate loss regime that also took effect in April 2017. With the changes to the loss rules only allowing £5million of losses to be set against profits (and up to 50% of profits thereafter), this could add an additional layer of complexity in the compliance process.
Lesson 3: Determine the worldwide group
In order to determine the worldwide group, companies are required to identify an ‘ultimate parent’ company and its consolidated subsidiaries, applying IAS principles.
Based on our experience, determination of the worldwide group often requires detailed accounting analysis, particularly where the ownership structure is less clear cut.
A key challenge is to obtain the relevant data required to calculate the UK tax inputs (those based on the UK tax returns) and the group accounts inputs (those based on the financial statements of the worldwide group). The data may also require specific adjustments for corporate interest restriction purposes, which can present a significant compliance burden. Common adjustments include those relating to IFRS 16 leases or derivative contracts.
Lesson 4: Review elections where possible
The CIR rules also contain a number of elections that may be beneficial in mitigating the amount of any interest restriction. Each election has its own detailed conditions and operative effect. While a number of election decisions can be reviewed annually, many of them are irrevocable, or can only be revoked after a certain period.
In general, groups should ensure that they carefully consider and model the impact of any elections to ensure that these can be made within the necessary deadlines, if relevant.
Lesson 5: Support with CIR calculations and compliance
Five years on and the CIR rules continue to present significant complexity, increasing the compliance burden on many groups. Many clients require help to navigate these issues, particularly as many businesses have struggled with cash flow over the course of the pandemic, leading to an increase in their debt facilities.
Specialist tax advice can help companies navigate the corporate interest restriction rules by reviewing or supporting the preparation of your CIR workings and annual filing requirements.
To discuss this topic further, get in touch with Mandipa Soni.