As anticipated, following the recent consultation, the Chancellor has announced that a cap will be introduced on the tax deductibility of interest for large companies. Broadly, this will be restricted to 30% of net earnings (EBITDA), with special rules for groups. It is intended that this cap will be brought in from 1 April 2017.
This move is in line with the OECD Base Erosion and Profit Shifting (BEPS) proposals to prevent tax avoidance by profits being shifted, through the use of interest payments on loans, out of the jurisdiction where the underlying activity is situated, to jurisdictions where lower rates of or no tax is payable. The measure is, however, wider than and not restricted to this sort of planning.
There is no mention in the announcement of the restrictions only applying to internal debt (eg shareholder loans), so it should be anticipated that it will apply to interest payable on third party debt also. While it is understood that HMRC was sympathetic to this limitation in a commercial context, they had concerns that it was not in line with the OECD proposals.
There is not yet any reference to whether the restriction will just apply to corporation tax (which was how the consultation was phrased) or whether it will also apply to income tax (relevant, for example, to offshore property companies holding property in the UK). At this stage, it is anticipated that income tax payers will be included in the measure also, as HMRC are aware of the discrepancy.
There will be a threshold limit of £2m aggregate group net UK interest expense. It is anticipated that this threshold will exclude 95% of groups from the application of the cap. There will also be a specific exclusion for infrastructure projects with a public benefit.
The industry, particularly those sectors which are often more heavily geared for commercial reasons, (such as real estate, infrastructure and private equity), has been lobbying for certain exemptions, in particular in relation to third party debt and for certain structures such as REITs which already have certain restrictions on overgearing. However, other than the limited exemption for certain infrastructure projects, nothing as yet seems to be forthcoming.
It should be expected, whatever the outcome of the legislation, that the impact of these proposals will be vast for certain businesses. Importantly, based on the consultation, it should be noted that the restriction will not just apply to interest, but also to other financing arrangements, such as use of derivatives, discounts etc which have a similar effect. We expect to see more of the detail in the draft Finance Bill which will be published on 24 March.
New business plans will need to take these changes into account and, since no grandfathering is anticipated, existing businesses will also need to review their structures.
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