Blunt instrument inflicts corporate pain

16 March 2016

A series of BEPS-related measures were announced to crackdown on multinational tax avoidance of which restrictions on interest deductibility are the most far reaching.

In the wake of the OECD’s release of final Base Erosion Profit Shifting (BEPS) package last October, the chancellor was quick to demonstrate his commitment to tackling tax avoidance by multinationals.

By far the most significant measure affecting large corporates is the restriction on interest deductions. Whilst this was expected it will have a significant impact on large corporates particularly those with high borrowings and low profitability.

A key departure from previous policy is that the measure will target debt from third parties as well as intragroup borrowings. In the past, the tax avoidance risk was seen to originate from the ability of groups to lend from one entity to another, all of which were under common control. This is no longer the case.

Another major change is that the rules do not apply an arm’s length test as is the case with the existing 'thin capitalisation' rules (which are not being repealed). In essence a group will be subject to a limit on corporate interest deductions of 30 per cent of the UK group’s EBITDA. So corporates will now be subject to the new rules with their fixed ratio test plus the existing thin capitalisation rules based on an arm’s length test.

There are a couple of get outs – a de minimis limit of £2m of net UK and a higher group ratio rule based on the worldwide group external net interest to EBITDA ratio. Also certain public infrastructure projects will escape the scope of the rules.

But any groups that are highly geared such as in the property sector or which are backed by private equity need to review their position.

The rules are subject to further consultation to address exactly how the rules will work and the scope for reliefs to address earnings and interest volatility.

There is some good news – the complex worldwide debt cap rules will become redundant and will be repealed. Also banks and insurance companies will be subject to separate rules which are still under consideration.

Time is short – these rules will be introduced from April 2017, which is not that long to review and potentially refinance a business.

If you would like to discuss how these announcements might affect you, please contact Ken Almand, Melanie Reed or your usual RSM contact.