Interest deductibility draft legislation published

Plans to introduce tough new rules to curb interest deductibility are taking shape as HMRC publishes draft legislation on the new regime for restricting the amount of interest and other financing amounts that a company can deduct when calculating profits for corporation tax purposes, effective April

The measures come into effect from 1 April 2017, when existing debt cap rules will be replaced with the new measure, which is expected to raise an additional £1bn of tax annually.

The UK has been an early adopter of the OECD’s Base Erosion and Profit Shifting (BEPS) action plan 4 on interest deductibility rules.

There is a £2m threshold for net interest expense, which will exclude 95% of groups from the new rules, claims HMRC, but estimates suggest they will afffect around 3,800 large businesses operating in the UK, many of which will be multinationals.

At present, the loan relationship regime at part 5 of Corporation Tax Act 2009 provides the current rules on corporate interest deductions. A number of other provisions deal with amounts that are equivalent to interest. The current debt cap rules are at part 7 of Taxation (International and Other Provisions) Act 2010 (TIOPA).

Under the new regime, legislation will be introduced in Finance Bill 2017 to be inserted into TIOPA, and will provide for repeal of the current debt cap rules.

The new rules will operate on a worldwide group basis forcing groups to manage any restriction across their businesses. They will apply to the net interest expense within the charge to corporation tax, including other similar financing costs.

The fixed ratio rule will limit the amount of net interest expense that a worldwide group can deduct against its taxable profits to 30% of its taxable earnings before interest, taxes, depreciation and amortisation (EBITDA).

A modified debt cap within the new rules will ensure the net interest deduction does not exceed the total net interest expense of the worldwide group.

The group ratio rule allows a ‘group ratio’ to be substituted for the 30% figure. The group ratio is based on the net interest expense to EBITDA ratio for the worldwide group based on its consolidated accounts.

There is an exemption for qualifying interest expense incurred by qualifying companies on funds invested in long-term infrastructure projects for the public benefit.

There are rules to help address timing differences between interest expense and EBITDA. Amounts of restricted interest are carried forward indefinitely. They may be deducted in a later period if there is sufficient interest allowance. Unused interest allowance can be carried forward for up to five years.

There are also specific clauses to deal with issues about related parties, joint ventures, leases, securitisation vehicles, real estate investment trusts, payments to charities, the oil and gas tax regime, double taxation relief and the Northern Ireland corporation tax rate.

In a policy paper, HMRC says the introduction of the restrictions may mean groups that have engaged in aggressive tax planning using debt to reduce their tax bill may face a higher cost of capital.

Tax experts have warned that the costs to businesses will be substantial as the new measures will change current use of intra-group loans and cross charged interest.

It will increase the cost of capital for multinationals that have proportionately higher borrowing in the UK compared with the rest of the worldwide group, as it will restrict the amount of corporate interest payments allowed to be offset against corporation tax liability.

Finance departments will incur substantial costs to change current reporting systems, expected to be around £16m in year one, while the ongoing administrative costs will be around £1m a year. 

HMRC expects to raise an additional £920m of tax in 2017-18, rising to £1.16bn in 2018-19, before falling to £995m and then £885m by 2020-21.

The closing date for comment on the draft legislation is 23 February 2017. (Email responses to interest-restriction.mailbox@hmrc.gsi.gov.uk )

Draft legislation: corporate interest restriction is here

The HMRC policy paper, Corporation Tax: tax deductibility of corporate interest expense, is here

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