Deductibility of corporate interest expense: further draft legislation

The UK Government has released further draft legislation for implementing the restrictions on deductibility of corporate interest, superseding the draft legislation contained in the draft Finance Bill released in December 2016. The new draft legislation covers the remaining elements of the interest restriction rules, as well as amending a number of the existing provisions. These include splitting all the administrative provisions into a new schedule of TIOPA 2010, but also making a number of more substantive amendments following feedback received on the earlier draft legislation.

Background

The OECD’s final report on Action 4 recommended that jurisdictions should introduce a rule which limits deductions for interest to a fixed percentage (between 10% and 30%) of a company’s earnings before interest, tax, depreciation and amortisation (EBITDA). However, the report recognised that the fixed ratio rule might be ameliorated by supplemental provisions, including:

• a group ratio rule, where the wider group’s actual ratio of external borrowings to earnings is higher than that allowed in a particular jurisdiction
• a de minimis provision to carve out smaller companies and groups, and
• an exclusion for interest paid to third party lenders on loans for public benefit projects.

Following consultation in May 2016, the Government released (partial) draft legislation in December 2016 to implement the fixed ratio rule and each of the exclusions from the restriction contemplated by the OECD recommendations.

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 “Tax deductibility of corporate interest expense”.

Further draft legislation

The draft legislation released in December 2016 was not complete. In particular, a number of areas were not covered in the rules, including the following:

• the group ratio rule definitions
• rules defining related parties
• elective rules to apply to qualifying companies investing in public infrastructure
• rules for particular issues and industries such as the Patent Box and other tax incentives, companies operating inside the oil and gas ring fence, leasing, and Real Estate Investment Trusts, and
• rules to apply an optional “blended” group ratio where a group has one or more related party investors.

Group ratio election

As an alternative to using the normal calculation of the group ratio, the redrafted legislation allows a group to elect to use a “blended” group ratio instead. This election allows a group to calculate its group ratio percentage with reference to the group ratio percentage of one or more related party investors. In this case the group ratio percentage is determined by calculating a weighted average of the applicable percentages for each investor. Each applicable percentage is the highest of 30%, the ratio for the group calculated in accordance with the normal group ratio rule and (if the investor is a member of a separate worldwide group) the group ratio for that investor’s group. Each applicable percentage is weighted by that investor’s interest in the group.

Related parties

Financing costs to related parties will be disregarded in calculating qualifying group-interest. This will mean that financing costs due by a group to related parties will not increase a group’s ability to recognise tax effective deductions for financing costs in excess of the 30% limit provided for by the Fixed Ratio Rule. The new draft rules now include the definition of “related parties”. Essentially, a person will be a “related party” where: (i) they are part of the same consolidated group; (ii) there is common participation in the management, control or capital of the parties; or (iii) the 25% investment condition is met.

Public infrastructure

The expanded draft legislation now includes the draft rules for implementing the public infrastructure exemption. These rules are mainly along the lines announced in the December 2016 consultation response document, however a number of changes have been introduced. In particular, it will be necessary for a company to elect to be within the exemption regime. This election will be revocable once it has been in place for five years, however, once revoked, a new election will not be possible for a further five years.

Anti-avoidance

The anti-avoidance rules contained in the draft legislation are typically widely-drawn, catching any type of “arrangement” that has a main purpose of enabling a company to obtain a “tax advantage” which is attributable to manipulating amounts of “tax interest expense”.

However, the Government have included a safe harbour for arrangements which would otherwise be caught by the anti-avoidance rules if “the obtaining of any tax advantages that would otherwise arise from them can reasonably be regarded as arising wholly from commercial restructuring arrangements entered into” in connection with the entry into force of the new rules. This appears to be designed to allow companies to restructure their existing arrangements so as, for example, to take advantage of reliefs within the rules.

Comments

Comments on the revised draft legislation and explanatory notes should be submitted by email to interest-restriction.mailbox@hmrc.gsi.gov.uk by 23 February 2017.

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".