Corporate interest restriction: Finance Bill provisions

Amended legislation for the enactment of the new rules to restrict the amount of corporation tax deductions available for interest and other financing costs was published in the Finance Bill (FB 2017) on 20 March 2017. The legislation in the Finance Bill contains a number of significant changes to the previously released draft legislation, including several that were outlined in the Spring Budget.

Background

The new rules are designed to implement the recommendations in the OECD’s final report on BEPS Action 4. Following consultation in May 2016, the Government released (partial) draft legislation in December 2016 to implement the recommended fixed ratio rule and this was followed by further draft legislation in January 2017 dealing with other aspects of the rules.

In outline, the UK Government will introduce a “fixed ratio rule” set at 30% of EBITDA, subject to a £2m de minimis threshold. In addition, the UK will implement the group ratio override rule where the worldwide group’s interest ratio exceeds the 30% limit and also provide an exception for public benefit infrastructure projects. However, the UK also intends to retain the fundamental premise of the existing worldwide debt cap rules - that the borrowings of the UK group should not exceed the external borrowings of the worldwide group - albeit by integrating it within the new rules. Despite widespread concern over the unnecessarily hasty introduction of the new rules, the Government will implement the new interest restriction with effect from 01 April 2017 and there will be no general grandfathering for interest on existing debt.

For more details of the draft legislation, see “Deductibility of corporate interest expense: further draft legislation”.

Finance Bill

The Spring Budget 2017 announced that the FB 2017 would include several changes from the earlier draft legislation published. Some of the more noteworthy changes include:

• The provisions which retain the debt cap rules in modified form are more clearly labelled and identified in a new separate section (section 400) as the "fixed ratio debt cap" and "group ratio debt cap". In addition, this provision includes a new ability to carry forward any excess "debt cap" available in a period of account to subsequent periods to facilitate deductions for carried forward disallowed interest expense.

• The provisions which deem third party debt that is guaranteed by a related party to be related party debt (section 466) have been narrowed so that they will not apply to any guarantees provided before 01 April 2017. In addition, a new provision will exclude certain intra-group guarantees from the scope of this rule when applying the group ratio method (section 415).

• As announced in the Spring Budget, a new section (section 450) has been added which will extend the concept of interest to include amounts arising directly from dealing in financial instruments as part of a banking trade (excluding amounts in respect of impairment losses).

• Including within the calculation of "adjusted net group-interest expense" amounts recognised in equity or shareholders' funds in respect of certain regulatory capital instruments (section 413).

• A number of changes have also been made to the public infrastructure exclusion, including (i) simplifying the qualifying company conditions where there is an insignificant amount of non-qualifying income or assets in a period (section 433); (ii) adding a new ability for members of a group to elect to satisfy qualifying requirements on a group basis (section 435); and (iii) excepting certain related party guarantees from the provisions which would prevent interest being exempted (section 438).

• Extending the period in which groups can replace a previously submitted abbreviated interest restriction return with a full interest restriction return to five years (it is only possible to carry forward surplus interest allowance from any period for which a full interest restriction return is submitted) (Schedule 7A paragraph 9).

• The previous exemption from the definition of interest for “gains that arise in the course of dealing in derivative contracts so far as that activity forms part of the activities of a trade” has been removed and a new exclusion for gains on a derivative contract that hedges risks arising in the ordinary course of a trade and which do not relate to the capital structure of the group has been added (section 411(2)).

Comment

The Finance Bill was published on 20 March but opportunities for further amendment still exist as the Bill makes its way through Parliament. However, given that the new rules will have effect for accounting periods beginning on or after 01 April 2017, it is far from ideal that changes to the law are being introduced, in effect, with retrospective effect in some cases. This merely goes to reinforce the concerns over such a major change being introduced in such a short period of time.

Update

For more information on the public benefit infrastructure exemption and, in particular, its application to UK property businesses, see "New corporate interest restrictions: impact on real estate financing".