Andy Keates provides a brief guide to the new regime for interest deductions by large companies and groups, which replace the “world-wide debt cap” rules from 6 April 2017.
The new rules are contained in Schedule 7A of TIOPA 2010. Most of us can happily ignore those 156 pages of legislation, as they only apply to extremely large interest deductions (in excess of £2 million). This happy ignorance can also extend to the amendments which are currently passing through Parliament as part of the Finance Bill 2018, and to the 577 pages of HMRC guidance which was updated on 28 February 2018.
However, for those of you who would like to keep an eye on what is happening for interest deductions (but don’t have the time or inclination to wade through 577 pages of HMRC-speak), here is a very brief summary.
Why the change?
This is not purely an HMRC initiative, it stems from a drive by the OECD and G20 to tackle base erosion and profit shifting (BEPS). In other words: the ambition of some multinational groups to have their interest receipts exposed to a low-tax regime, while their interest expenditure is relieved in a high-tax jurisdiction.
This legislation is HMRC’s way of implementing the UK’s response to BEPS, with the stated aim to “ensure relief on financing costs is commensurate with the extent to which a business's activities are subject to [UK] corporation tax”.
Who is affected?
All companies subject to UK corporation tax are potentially caught, but there is a de-minimis limit below which the rules don’t apply, subject to voluntary involvement (see below). The de-minimis limit is expressed as: where, in any accounting period, the net tax interest expense (interest expense minus interest income) is £2 million or less.
This limit relates to the group rather than the company: it is the aggregate position for all the UK-taxable companies in a given worldwide group. For these purposes, a group consists of an ultimate parent company and all its consolidated subsidiaries if any. A single company worldwide group is included, although we wouldn’t normally consider a singleton company to be affected by group legislation.
The ultimate parent can include any entity which is listed on a recognised stock exchange and is sufficiently widely held, such that no single participator owns more than 10%. It is, therefore, possible for companies owned by a Limited Liability Partnership (LLP) to be subject to this new interest regime.
How does it work?
A total restriction on interest deductions is calculated on a group-wide basis and then allocated between the relevant companies – either at the discretion of the group’s reporting company or pro rata (proportional to each company’s net interest deduction).
The calculation compares the group’s aggregate net tax interest expense with an interest allowance, which may be computed in various ways, of which the most straightforward is 30% of tax-EBITDA. If the expense exceeds the allowance, the surplus is restricted.
Restrictions allocated to a company are added back, increasing the company’s taxable profits for the relevant accounting period(s). The company should keep a record of these restrictions since they can be reactivated in subsequent years if the group’s interest allowance exceeds its interest expense. Reactivated amounts count as fresh allowable expenses of the later year, of the same type as was originally disallowed.
The right to reactivate is without time limit: amounts which have yet to be reactivated are a potentially valuable tax attribute, which remains with the company even if it leaves the group.
In any year where the group’s interest allowance exceeds the interest expense plus any reactivated amounts, there is an ability to carry forward the unused allowance for up to five years. This, combined with reactivation, allows a group to smooth out the effect of fluctuating annual results.
Unlike reactivated amounts, the unused allowance belongs to the group as a whole and will be lost if the identity of the ultimate parent changes.
The group should nominate a reporting company, which must make a full return on behalf of the group as a whole. HMRC has made available worksheets for calculating the interest restriction and forms for appointing a reporting company. If no reporting company has been nominated, but it is clear that returns will be required, HMRC can designate one.
If a group is currently covered by the £2 million de minimis limit, no action is required other than to maintain sufficient records to demonstrate that it falls below the limit.
However, the group may choose to file an abbreviated return for the period. This acts as an insurance to claim the interest allowance. If in the next five years the group becomes subject to the restriction regime, it can replace the abbreviated return with a full return and bring forward any unused allowance.
For groups where there is a risk that the net interest expense might at some stage exceed £2 million, this could be a useful safeguard.
Your response to these provisions depends on the companies with which you are involved.
- If they are never going to be in a situation where their net interest expense exceeds £2 million, you can safely ignore the rules;
- If they aren’t now, but might be at some future stage, consider voluntary involvement, with abbreviated returns to protect unused interest allowances;
- If they already have net interest deductions of more than £2m, you need to know the new rules, and at far greater depth than is possible in this article. You will probably need to read those 577 pages of HMRC guidance!