A further consultation on restricting interest and finance costs for UK corporation tax purposes was released on 12 May 2016. The document contains 92 pages. As the property sector is generally highly geared, the proposals will impact on this sector more than others.
Overview of proposals
We have summarised the key points below:
- It is proposed that the proposals will apply from 1 April 2017
- A Fixed Ratio Rule is proposed limiting a group’s UK tax deductions for net interest expense to 30 per cent of its tax adjusted EBITDA (Earnings before interest tax depreciation and amortisation).
- Where a worldwide group’s net external finance costs are higher than 30 per cent, that higher ratio can be used but is likely to be subject to further conditions.
- The first £2m of net UK annual interest incurred by a group will not be affected by these rules and therefore for the vast majority of tax payers, finance costs will be deductible in full.
- The worldwide debt cap legislation will be repealed and some restrictions incorporated into these new rules.
- Finance costs will include interest and other amortised finance costs but generally not exchange losses. They also include the finance element of leases.
- Restricted finance costs can be carried forward and treated as deductible in future years subject to the ratio restriction. Unused interest capacity can also be carried forward for three years.
- The consultation states that ‘The Government is considering whether and how the interest restriction rules should apply to companies with a liability to UK income tax’ and therefore no decision has been made how this would affect non-resident landlords.
- Special rules will apply to REITs which should prevent an undesired impact on their distribution requirements.
What does this all mean?
As the property sector is generally highly geared, these restrictions will have a significant impact.
The good news is the £2m de-minimis limit will take many groups outside the rules.
For groups which are solely UK tax resident, the higher group ratio may still not give them a full deduction for third party finance costs. Each situation should be modelled as the calculation of the restriction may result in unexpected amounts being disallowed or deferred.
For worldwide groups with UK subsidiaries or UK permanent establishments, third party and mezzanine loan interest may now be restricted further. To obtain a finance deduction above 30 per cent of EBITDA, disclosure to HMRC of additional group financial information will be required. This could subject such groups to unwanted additional scrutiny from HMRC.
For non-resident landlords investing in UK real estate, there remains uncertainty as to whether these rules will apply to them. However, given the government’s attempts to limit the advantages of offshore planning, it is likely to be a question of when, rather than whether they will apply.
What do you need to do?
All businesses affected should identify their exposure and the financial costs and consider what action can be taken. The rules are complex and need to be applied on a case by case basis.