Following on from early announcements, the UK government has now published a consultation document setting out more details on their proposals to restrict the deductibility of certain corporate interest expense from 1 April 2017.

The essence of the proposals have not changed from those announced in the March Budget and before, but we now have much more clarity around some of the detail as to how the government is thinking.

The proposals pre-empt, but largely follow the proposals set out by the OECD in their Base Erosion and Profit Shifting (BEPS) proposals to prevent tax avoidance by multi-national groups. They do, however, contain quite a lot of complexity, with new definitions and amended definitions, resulting in some surprising implications which individual businesses should consider carefully and, on which, if relevant, they should make appropriate representations. The following highlights a few points which caught our eye.

Start date

It is proposed that the rules come into force from 1 April 2017.


It is not proposed that there would be any grandfathering, other than, potentially, in "exceptional circumstances" (see public benefit infrastructure below).

Corporation tax

At present, importantly, the proposals to restrict interest deductions are confined to corporation tax. In particular, they do not cover income tax, which is more generally paid by non-resident landlords. HMRC are quite aware of this discrepancy and the consultation contains 2 lines on the fact that they are considering "whether and how" the rules could be applied to corporate non-resident landlords. Given the complexities potentially involved, even if the rules are to be extended to income tax (and given the scale of the UK property held by non-residents this is generally considered to be quite likely), it is unlikely to be on the same timescale of next year. At least for the time being, there would, therefore, seem to be a reprieve for non-residents holding property in the UK as an investment.

The basic proposition

Very broadly, the rules will cap deductions for "interest" in a company or group:

  • at 30% of EBITDA (the "fixed ratio rule"); or
  • optionally, at tax EBITDA x group ratio being net qualifying interest of the worldwide group / worldwide group EBITDA (the "group ratio rule")

in both cases subject to a cap of the net qualifying interest of the world-wide group.

De minimis

There will be a £2m de minimis for each group (not company), to reflect the fact that the measure is targeted at large multi-nationals and BEPS.

For companies and groups where net annual interest is £2m or less, the rules will not apply at all. It is clearly intended also that the de minimis will take that amount of interest out of the scope of the rules entirely - even where they may otherwise apply (see below) - so that every company is able to benefit from it. The government considers that the de minimis should take 95% of companies out of the rules.

Fixed ratio rule

Very broadly, under the fixed ratio rule, the rules will cap deductions for "interest" for large companies at a maximum of 30% of net earnings (calculated using an amended definition of interest and an amended definition of EBITDA respectively (see more on this below)) ("tax EBITDA").

Restricted interest can be eliminated by spare brought forward capacity from earlier periods (though spare capacity can be carried forward for three years only).

Restricted interest can itself be carried forward indefinitely for use in subsequent periods, subject to there being sufficient capacity.

If there is excess interest expense which cannot be deducted, companies will, however, have the option to use a "group ratio rule" (see further below), which may give a better result (as will be seen below, this will, however, be fact dependent).

What is restricted?

In calculating the amount that is to be restricted under the fixed ratio rule, the rules introduce a new concept of "tax interest". This goes beyond what is actually interest, and includes, for example, interest on all forms of debt, payments economically equivalent to interest and expenses incurred in connection with the raising of finance.

As the rules are to limit tax deductions, the definition of tax interest (and net tax interest) is defined by tax terms. This is, broadly, financing income less financing expenses. It includes some obvious items, such as loan relationship debits (which usually include guarantee fees) and derivative contract debits, but also some less obvious ones, such as financing costs implicit in payments under certain leases (on which see further below) and financing costs on debt factoring and on service concessions accounted for as a finance liability. Impairment losses and break costs of loan relationships will also be included.

In dealing with the rules, other tax rules also are applied. For example, the rules attribute the interest to corporate partners in a partnership, where the partnership borrows or lends money. This may potentially lead to a different treatment of partners in partnership joint ventures to those in corporate joint ventures, which may change the way partners consider entering into joint venture arrangements.

The rules expressly also include capitalised interest under section 320 Corporation Tax Act 2009 (which it appears may be different to the proposed treatment of capitalised interest under the group ratio rules (on which see more below and which may give rise to more deliberation over the distinction between trading as compared to investment arrangements and which ratio to use)).

Taking tax focus on tax definitions a logical step further, perhaps obviously, tax interest takes into account amounts taxable or deductible after taking account of transfer pricing, unallowable purposes, anti-hybrid rules, group mismatch rules and distribution rules.


Again this is to have a special definition. Broadly tax EBITDA is profits subject to corporation tax which are brought into account for the year, which are not interest, deprecation or amortisation. It will include net chargeable gains. Net capital allowances positions (being effective depreciation) will be excluded. Losses brought forward and group relief will be excluded.

Third party debt

There was lobbying that genuine third party debt should be excluded from the rules, but there is to be no general exclusion for third party debt, notwithstanding that there may generally be no BEPS (but see below on public infrastructure projects). Accordingly, the rules could potentially restrict the deductibility of interest on third party debt also. Not all businesses are, however, highly geared, so that the rules will have greater impact on certain types of business, such as real estate and infrastructure, where companies take on gearing for commercial reasons.

Modified world-wide debt cap

While the world-wide debt cap rules generally will be repealed as part of this reform, a modified form of the cap will be incorporated into the new rules themselves. The effect of this will be to limit the deductions to the net allowable interest of the worldwide group Its retention introduces also a potential discrepancy in the treatment of UK only and non-UK groups, which HMRC recognises will potentially bring deductions to below 30% in the case of the latter: the express aim is, however, to stop companies with little net debt obtaining interest deductions up to the 30% fixed ratio limit.

Group ratio rule: good news?

Nonetheless, the government is aware of the potential commercial ramifications of the new rules for heavily geared industries in the UK and, so, as permitted by the OECD proposals, has allowed an optional group ratio rule for groups. This, it is intended should effectively, in many cases, allow most or all of external debt to be deductible. "Recognising that some groups may have high external gearing for genuine commercial purposes, the government announced at Budget 2016 that the new rule will include a Group Ratio Rule based on the net interest expense to EBITDA ratio for the worldwide group, as recommended by the OECD report. This should enable businesses operating in the UK to continue to obtain deduction for interest expenses commensurate with their activities, in line with the worldwide group's financial position".

There are, however, in practice, some potential issues with this, that companies should be aware of

  • of which, hopefully some, at least will get ironed out in the next phase of the consultation process
  • some of these are picked up below.

The first is that notwithstanding that potentially the group ratio rule will allow third party debt in the UK to be deductible, as with the fixed ratio rule, this will again be subject to a further cap of the overall net qualifying interest of the worldwide group under the modified debt cap rule, which HMRC accepts could in practice limit deductions for external debt in the UK.

The group ratio rule will incorporate many of the rules of the fixed ratio rule, but will work on a different basis. It will replace the interest limit of tax EBITDA x 30% (used for the purposes of the fixed ratio rule) with a "group ratio":

net qualifying group-interest expense

group EBITDA

Where the group EBITDA is zero or negative then the cap of net qualifying group-interest expense will apply rather than a ratio.

While (as stated above) the tax EBITDA for the purposes of the fixed income rule will be defined by (amended) tax concepts, the group ratio will, however, be defined by (amended) accounting concepts of the consolidated worldwide group. For this purpose, certain standards will be recognised as permissible, with a likely default of IFRS.

This brings about the possibility of mismatches. For example, factors such as revaluation of assets in accounts or fair value of swaps will be included. Accordingly, where assets have been revalued upwards, this could cause a reduction in the amount deductible, notwithstanding the intention of the group ratio rule, to allow deductions for third party debt. We expect some lobbying on this point.

In applying the group ratio rule, to prevent undue weight being given to the net interest line in the equation, which would increase the level of deductions, certain types of "interest" will be excluded from the calculation. These will be basically those types of returns that would not normally attract interest deductions in the UK or which have equity like returns. It will also exclude perpetual debt (ie 50 plus year loans), though on demand loans will not be included, Importantly, it will also exclude related party debt. This will be widely defined to include "significant interests of 25% or more and where parties are "acting together". These could all potentially have substantial commercial implications and returns.

Capitalised interest will be included regardless of the nature of the asset or its tax treatment.

Net interest and group amortisation and depreciation will be added back in determining the group EBITDA.

Definition of "group"

This too will be defined according to accounting principles - the IFRS definition being the one that is to be adopted. The proposal is that the ultimate parent and all companies consolidated on a line by line basis - excluding associates and joint venture companies - will form a group, with the ultimate parent - generally having to be a company itself (the exception being a non-corporate entity listed on a recognised stock exchange where no participator owns more than 10%). Joint ventures should form their own group. Specific rules will be incorporated to deal with issues such as stapled stock. While it is not intended that there should be a specific carve out, it is not considered that collective investment vehicles would generally form part of a group, but this should be considered on a fact by fact basis.

Public benefit infrastructure

The proposals around public benefit infrastructure have come in more harshly than was perhaps anticipated, in particular, with limited grandfathering. Though the government does recognise that some grandfathering may be necessary to protect the viability (taking account of debt covenants) of public infrastructure projects, the proposals state that provision for grandfathering would only be made if there is evidence that any adverse impacts of the new rules connected to infrastructure finance would be systemic, could not be mitigated in other ways and if rules can be designed to limit distortions and tackle BEPS.

It is generally anticipated by HMRC that most projects should, nonetheless, benefit from full deduction, provided the project vehicle is not consolidated with any of the investors and that the add back of financing income in the group EBITDA will be netted off by interest expense. This will, of course, be a question of fact.

There will be a potential public benefit project exclusion from the rules, but this will be very narrow. Very broadly, it will be effectively limited to third party lending for government services, which the operator is contractually required to provide, where assets cannot be sold for at least 10 years and where the profits are subject to UK corporation tax. As the impact of this could be quite radical, since these projects are generally heavily geared, the precise wording around the proposals should be considered carefully by those potentially affected.

Real estate investment trusts

It is proposed that the rules will be adapted in some way to apply also to REITs, though these already have their own in built rules to prevent excessive interest costs. There is, as yet, no detail.

Alternative Investment Funds, Investment Trust Companies and PAIFs

These pay amounts out to shareholders as interest or deemed interest and as the policy is to tax these amounts at shareholder level these payments will not be taken into account. Any third party debt would be, in the usual way.

Oil and gas

It is proposed that the new rules should only impact on activities outside the ring-fences. Two options are proposed which should be considered carefully, where relevant.

Banking and insurance

Deliberations are still going on as to how the rules will apply to these two industries.


Treatment of payments under certain finance leases, as "interest" could potentially have an unexpected effect. This could impact on real estate and other assets, where people would not initially consider sums payable as rental to be subject to the regime. This aspect would merit further consideration.


At present, unlike transfer pricing, there seems to be no adjustment measure, so that the restrictions could potentially give rise to double taxation - ie loss of deduction in the payer and taxation in the recipient. This it seems is deliberate - a revenue raising measure for the government?

The carried forward interest will not be treated as a loss and so will be unaffected by the proposed reform of the treatment of losses (a consultation on which has also just been announced).

The implications will no doubt have major consequences for many real estate and private equity real estate businesses.

Lenders are now starting to look carefully at pricing and covenants and will do so more, now that it seems clear that there will be no general grandfathering or exclusion of third party debt. Time will tell how much the change will influence investor behaviour or change practice and structuring, but it certainly will impact on modelling and returns. These measures will, of course, accelerate the tax take for the government, and so, while the industry may well lobby for a postponement until they are in good shape to avoid unexpected consequences, it is unlikely that the proposals will go away.


This consultation closes on 4 August 2016, so that, to the extent businesses wish to make responses, they should do so before then. While industry bodies will be making co-ordinated considered responses, it is considered that empirical evidence provided by individual businesses can provide as to how the rules work (or perhaps more importantly may not work) for them will be highly relevant in determining the final shape of the new legislation.