The new rules apply from 1 April 2017 to interest payments made from that date under new and existing loans: no grandfathering is available for existing loans.
Previously, the tax deductibility of corporate interest expenses broadly depended on the amount of interest which would have been lent by a third party in the same circumstances (without any related party support, such as a parent guarantee). The new rules operate after the application of this arm’s length test, so that they potentially restrict the tax relief on interest which passes that test – even interest on third party debt.
Under the new rules, the starting point is that tax relief for interest is limited to net tax-interest expenses of up to 30 per cent of a group’s UK tax-EBITDA for the relevant period or, if lower, the adjusted net interest expenses of the worldwide group (ANGIE) for that period. Certain loan relationship and derivative contract debits and credits are included in calculating net tax-interest expenses, and the tax-EBITDA of a company means its corporation tax profits or losses after making certain adjustments.
However, the following important exceptions apply:
- A de minimis threshold: tax relief on the first £2 million of the group’s net UK interest expenses for each period is not restricted. This threshold applies to the whole group, not to each entity separately. Any disallowed tax relief can generally be carried forward and received in a future period with headroom in that threshold.
- A group ratio rule: an entity may elect to receive tax relief on its net UK interest expenses up to the level of the qualifying net group-interest expense (QNGIE)/EBITDA ratio of its worldwide group for the relevant period (or, if lower, the QNGIE of the worldwide group for that period). The group ratio rule is intended to cater for groups with high external gearing for genuine commercial reasons. However, the ANGIE and QNGIE concepts mean that groups with higher leverage in the UK than elsewhere may have the tax relief restricted on their UK interest, even if this disparity arises for sound commercial reasons. Moreover, expenses on related party debt (which includes unconnected debt guaranteed by a related party on or after 1 April 2017 and debt from an owner of at least 25 per cent of the voting or economic rights), equity notes and results-dependent securities must be deducted in determining the QNGIE. As a result, foreign groups which have issued debt to fund UK sub-groups are particularly at risk under the new rules, but even a wholly UK group may not receive tax relief for all its external interest expenses.
- A public-benefit infrastructure exemption: qualifying infrastructure companies are able to make an election to be excluded from their group’s interest restriction calculations. Significantly, buildings which form part of a UK property business and are, or are to be, let on a short-term basis (broadly, 50 years or less) to an unrelated party qualify as infrastructure assets. This should benefit certain commercial property groups, provided that the following conditions are met:
- all of the company’s profits and gains are fully chargeable to UK tax;
- broadly, the debt for which exemption is sought must be provided by an unrelated party or a qualifying infrastructure company and can only be secured on the income, assets, shares or debt of the company or other qualifying companies;
- any non-infrastructure activities carried on by the company are insignificant; and'
- the company does not have subsidiaries outside the UK corporation tax net.
- An unconsolidated joint venture can make a group ratio (blended) election, to alleviate the fact that its shareholder debt would be unlikely to count towards its group ratio (given the wide definition of ‘related party’). This election broadly allows an unconsolidated joint venture to calculate its group ratio by reference to a blended ratio which takes account of an appropriate proportion of each investor’s group ratio.
- The banking and insurance sectors have managed to achieve some limited changes to the way in which the rules specifically apply to them.
- The rules do not currently apply to companies subject to UK income tax, such as foreign companies with a UK property investment business. However, we expect the rules to be extended to cover those companies in the relatively near future.
How we can help
The new rules are detailed and intricate, and their application will throw up some surprises. If you would like to discuss how they apply to your particular situation, please get in touch with Caspar Fox, Gareth Amdor, Simon Gough, Philippa Michie and Laura Gould or your usual Reed Smith contact.