CORPORATION TAX - 29.10.2018

Understanding the corporate interest restriction rules

Background

The legislation contained in Part 10Taxation (International and Other Provisions) Act 2010 restricts the amount of interest and other finance costs a group of companies can deduct for tax purposes. This legislation, known as the corporate interest restriction (CIR), is highly complex and was brought in as part of the base erosion profit shifting project (BEPS). We introduced you to BEPS in yr.2, iss.7, pg.9 (see Follow up ).

The CIR applies for all accounting periods ending after 1 April 2017 and restricts the deduction of interest (and similar expenditure) where certain limits are exceeded. The CIR is only likely to be applicable to larger corporates as there is a de minimis value of £2 million of interest expense before the restriction is triggered.

Pro advice 1. The legislation refers to a “worldwide group”, however the restriction is only based on those companies in the group that are subject to UK corporation tax. Therefore, the amounts and calculations needed to determine a restriction will only be based on figures included in the UK tax computations.

Pro advice 2. Even though the legislation refers to a group, a single company can be a group for CIR purposes, so you should consider the CIR legislation for all your UK company clients.

Key definitions

There will be an interest restriction where a group’s net tax interest expense exceeds its interest capacity. For these purposes:

• interest capacity is the higher of the £2 million de minimis (pro rata for shorter periods) and the interest allowance
• the interest allowance is 30% of the group’s tax earnings before interest tax depreciation and amortisation (EBITDA). This is called the fixed ratio
• net tax interest expense is the group’s tax interest expense less its tax interest income; and
• tax interest includes interest received and paid, i.e. loan relationship debits and credits, but also amounts akin to interest such as the finance costs of finance leases, certain derivative contracts, and costs associated with loan relationships. Foreign exchange gains or losses are not included in the definition of tax interest.

Pro advice 1. If a group is highly leveraged it may be beneficial to elect that the interest allowance is calculated by reference to the group ratio if that is higher than the fixed ratio. The group ratio is the group’s net interest expense compared with group EBITDA.

Pro advice 2. The new international accounting standard on leases ( IFRS 16 ), which comes into force from January 2019, no longer distinguishes between a finance lease and an operating lease for accounting purposes. However, HMRC has confirmed that for CIR purposes lessees applying IFRS 16 will need to continue to distinguish between the two, with finance costs of a finance lease being within the definition of “tax interest”.

Calculation in practice

Example. You act for a two-company group in which both companies receive interest on their cash at bank and both pay interest on their loans. The group profit before tax, interest and depreciation/amortisation is £5m. The interest details and the CIR calculation work as follows:

The net interest expense is greater than the interest capacity, therefore not all of the £2.475 million tax interest expenditure can be deducted in this year’s tax computation. As 30% of the group’s EBITDA was less than the £2 million de minimis value, the interest capacity is the de minimis amount.

Pro advice. If the net tax interest expense is less than £2 million there will not be an interest restriction.

Carry forward of restriction

Where the interest is restricted, the relevant amount can be carried forward indefinitely. Relief can be obtained when the interest allowance exceeds the net interest expense.

Pro advice. The carried forward amount for disallowed interest is on a company-by-company basis, not on a group basis. Therefore, if a company leaves a group, say because it is sold, it can take the carried forward amount with it and reactivate the deduction in the new group. The group can allocate the restriction to whichever company it wants.

Example. Continuing the example from above into year 2, the net tax interest expense is the same as year 1, i.e. £2.475 million, but the EBITDA has doubled to £10 million:

So the group can deduct the full £2.475 million in interest expenses. However, it can also deduct the unrelieved £475,000 that was restricted in year 1.

Carry forward surplus allowance

If the interest allowance is greater than the net tax interest expense, the surplus interest allowance can be carried forward for a period of five years and used to increase a later year’s interest allowance amount. Brought forward interest allowances are used on a first in, first out basis to use the older surpluses first.

Pro advice. The surplus interest allowance carried forward is on a group basis and will be lost if the group ceases to exist, e.g. where the group is purchased by another company.

Example. The facts are as in the first example, but it is year 5, and there is a surplus interest allowance of £975,000 from prior years to use. This increases the interest capacity to £2.475 million, meaning there is no CIR.

Pro advice. If your group company clients are currently unaffected by the CIR because their relevant expenses are too small, but 30% of EBITDA exceeds the £2 million de minimis value, they can take a protective stance and claim its unused interest allowance in order that it can carry it forward. If the relevant expenses increase in future years they can then benefit from the carried forward allowance accordingly.

Interest restriction return

If a group has an interest restriction it will need to submit an interest restriction return to HMRC to provide details of the calculations (see Follow up ). The filing deadline is twelve months from the end of the relevant accounting period.

If a group does not have an interest restriction there is no need for it to submit a return. However if it wishes to carry forward any unused interest allowance, or reactivate a brought forward restricted interest amount, it must file a full return.

Before a return can be submitted, the group must nominate a reporting company and notify HMRC of the nomination within six months of the end of the accounting period. It must be appointed by the majority of eligible group companies, i.e. the group companies subject to UK corporation tax, but not dormant companies.

Previous article on BEPS

Online interest restriction return