The government confirmed in the Autumn Statement its intention to implement the Organisation for Economic Co-operation and Development’s base erosion profit shifting (BEPS) project recommendations on interest deductibility. This follows two rounds of consultation – a high-level one in October 2015 and another in May 2016 when the government set out its detailed design proposals. The new rules are due to have effect from 1 April 2017.
What will the new rules look like?
- The May 2016 consultation document sets out detailed proposals for the new rules. Under the proposals:
- Restrictions will be placed on the tax deductibility of “tax-interest” (which will include payments economically equivalent to interest and finance-raising expenses) by the introduction of a “fixed ratio rule”. Under the fixed ratio rule, a group’s deduction for tax-interest for a period of account will be restricted to 30% of its “tax-EBITDA” for that period. For the purposes of the fixed ratio rule, only group companies within the charge to UK corporation tax will be taken into account. In brief, tax-EBITDA is equal to corporation tax profits but excluding certain amounts in respect of interest, depreciation, amortisation and reliefs.
- A group can elect to apply the “group ratio rule” in place of the fixed ratio rule. Under the group ratio rule, the fixed ratio rule is applied as if the “30%” were replaced by the net “qualifying group-interest” expense divided by “group-EBITDA”. For the purpose of the group ratio rule, all members of the worldwide group are taken into account, with accounting (as opposed to tax) figures being used.
- A de minimis threshold of £2m of net UK interest expense per year will be introduced. The effect of the threshold will be that a group that has a net UK interest expense of £2m or less in a year will fall outside the new rules, with only net interest expense exceeding £2m being subject to the rules. The government believes that this threshold will exclude 95% of groups from the new rules.
- The worldwide debt cap rules will be modified with the result that a group’s interest limit (ie amount of deductible interest) will be the lower of the amount found by applying the fixed ratio rule (or the group ratio rule) and the amount found by applying the modified debt cap.
- A narrow public benefit projects exemption will be introduced. This is to ensure that private financing of public benefit projects (mainly infrastructure) are not affected.
What are the issues?
Initially, it was unclear if the new rules would apply to non-resident companies within the charge to UK income tax (eg non-resident landlords). However, following the Autumn Statement it is clear that such companies will be subject to the new rules, as they are going to be brought within the charge to corporation tax.
The complexity of the new rules, and the speed at which they are being introduced, is likely to make it difficult for taxpayers affected by the new rules to prepare for them. Additionally, there is some surprise at the UK taking a lead on this. The UK will be the first country to implement these rules, and as such there is concern that this will affect the country’s competitiveness, especially as Brexit looms large.
There is a general lack of transitional (grandfathering) provisions, which is likely to cause numerous issues for existing structures, especially where much time and effort has already been incurred in creating those structures.
Conor Brindley is a tax partner at Irwin Mitchell
