On March 31, 2017, the U.K. HM Revenue & Customs (HMRC) issued draft updated guidance on corporate interest restriction. The rules are contained within Part 10 of Taxation (International and Other Provisions) Act 2010. The corporate interest restriction will have effect from April 1, 2017, and all periods of account of a worldwide group beginning on or after that date will be subject to the restriction.
The rules apply to all companies within the charge to corporation tax; however, the restriction will not apply to groups with less than £2 million of net interest expense and other financing costs. Beyond this threshold, deductions will be limited to the group’s net third party interest expense, or a part that is proportionate to their U.K.-taxable earnings before tax-interest, depreciation and amortization (EBITDA). Deductions for profits from patents chargeable to a lower rate of corporation tax are excluded from the calculation of adjusted corporation tax earnings when determining a company's tax-EBITDA. Amounts that are disallowed in one accounting period may be carried forward and may potentially be deducted in a subsequent period. Unused interest allowance is carried forward for use in a subsequent period for up to five years.
In line with BEPS Action 4, the legislation has been designed to combat attempts by multinational enterprises (MNEs) and other companies to obtain excessive tax relief for net interest and similar financing costs. The aim of the rules is to restrict deductions for a group's net interest and similar financing costs (tax-interest) to an amount which is commensurate with activities taxed in the U.K., taking into account amounts the group borrows from third parties.
The first step is to identify the worldwide group, which typically consists of the ultimate parent and all its consolidated subsidiaries. Once this is established, that group's period of account must be determined. Once these are known, figures can be extracted from the financial statements to use for the relevant calculations.
Of the two methods applied in computing the basic interest allowance of the worldwide group for a period of account, the simpler method, which is the default method, is the fixed ratio method. Applying this method, the basic interest allowance is the lower of the following:
- Fixed percentage (30%) of the worldwide group's aggregate tax-EBITDA.
- Fixed ratio debt cap for the period.
The second method for computing the basic interest allowance of the worldwide group for a period of account is the group ratio method. This method is applied where the reporting company makes a group ratio election. This election may be revoked.
Applying this method, the basic interest allowance is the lower of the following:
- Group ratio percentage of the aggregate tax-EBITDA.
- Group ratio debt cap for the period.
The corporate interest restriction rules replace the existing Worldwide Debt Cap rules. The Worldwide Debt Cap rules will cease to have effect for periods of account starting on or after April 1, 2017.
The corporate interest restriction includes a regime anti-avoidance rule (RAAR) that counteracts tax advantages that may arise from certain avoidance arrangements. The arrangements must result in a tax advantage as a result of a company doing one of the following:
- Eliminating a restriction of tax-interest expense, or reducing the amount of a restriction.
- Reactivating amounts of disallowed tax-interest expense, or increasing the amount of a reactivation.
- Changing the timing of any restriction or reactivation of tax-interest expense amounts so that it is made in a different accounting period.
The RAAR will apply only if the arrangement gives rise to a tax advantage. A tax advantage may include the following:
- Relief from tax or increased relief from tax.
- Repayment of tax or an increased repayment of tax.
- Avoidance or reduction of a charge to tax or an assessment to tax.
- Avoidance of a possible assessment to tax.
- Deferral of a payment of tax or advancement of a repayment of tax.
- Avoidance of an obligation to deduct or account for tax.
The legislation applies only to arrangements where a main purpose is to secure a tax advantage. The legislation does not define what is meant by main purpose or one of the main purposes.