As announced in the Budget, and following the publication of the OECD’s recommendations on interest expense deductibility, as part of the Base Erosion and Profit Shifting (BEPS) project, the Government intends to introduce (further) rules to limit interest deductions by companies. The legislation will be introduced in Finance Bill 2017, to take effect from 1 April 2017.

On 12 May 2016 a consultation document was published which set out detailed design proposals for the new rules. Comments are invited by 4 August 2016. The consultation makes clear that  the target of the new rules are multinational groups who (i) borrow more in the UK than they need for UK activities, resulting in a “mismatch” between UK tax deductible interest and UK taxable income and/or (ii) enter into arrangements so that tax deductions are achieved both in the UK and elsewhere, in respect of the same interest expense.

The thrust of the new regime is that a group’s “net tax interest expense” (ie excess of finance expense over finance income) will be restricted if and to the extent it exceeds the group’s “interest capacity”.

“Interest capacity”, or the limit of a group’s tax deduction, is to be calculated by using either the Fixed Ratio Rule or the Group Ratio Rule, if greater than £2m.

Under the planned Fixed Ratio Rule, corporation tax deductions for net interest expense will be limited to 30% of a group’s UK EBITDA. It is the Government’s view that 30% is sufficient to cover the commercial interest costs arising from UK economic activity for “most businesses”.

As proposed, a group would be able to elect to adopt a Group Ratio Rule instead, which would substitute (in place of 30%) a % of UK EBITDA equal to the ratio of group 3rd party finance expense to group EBITDA. This could result in a reduced limit on tax interest deduction, and is designed for groups that are “highly leveraged for commercial reasons”.

A de minimis group threshold of £2m (net interest expense) will apply before the new rules apply. This will, according to the Government, mean that 95% of groups will be excluded from the new rules.

Any restricted interest expense will be capable of indefinite carry forward. However if interest capacity for a year exceeds the net tax interest expense, the “spare” net tax interest expense will only be able to be carried forward for three years.

The current “debt cap” rules will be abolished, as the new rules will include provisions that ensure that a group’s net UK interest tax deductions cannot exceed the group’s global net third party expense.

The consultation can be viewed here.