The new corporate interest restriction (CIR) rules, which are effective from 1 April 2017, represent a major departure from the UK's traditional approach to the tax treatment of financing costs.
They introduce a more detailed and complex formula-based approach than we have been used to in the past with respect to tax deductibility for interest and other financing costs. By not including a motive test, the potential restriction applies regardless of the intentions of the group (or company) concerned.
Overview of the CIR
The good news is that, under these rules, all groups will be able to deduct up to £2m of net interest expense in the UK per year. This generous de minimis amount should exempt the vast majority of corporates from the restriction.
Above this threshold, the new rules will broadly restrict a group's UK corporation tax deductions for its net interest expense (it’s interest allowance) to the lower of 30 per cent of UK taxable earnings before interest, tax depreciation and amortisation (EBITDA) and the worldwide group's net external interest expense. A ‘group ratio’ election can also be made and may provide a better result to the extent that the worldwide group’s net interest expense as a percentage of worldwide group EBITDA is greater than 30 per cent.
The rules also contain helpful provisions designed to mitigate effects of fluctuations in future profitability and funding costs. Amounts that are disallowed in one accounting period can be carried forward indefinitely and may potentially be reactivated, and deducted, in a subsequent period. A group can also carry forward its unused interest allowance for an accounting period for up to five years.
Having applied the CIR rules, it will be appropriate for certain groups to file an interest restriction return (IRR).
An IRR will be necessary to:
- allocate any interest disallowance to specific companies within the group (the precise allocation may require thought depending on the group’s tax profile);
- carry forward interest allowances to future periods;
- make various CIR elections; and
- reactivate previously disallowed interest (where the group has interest capacity in future periods).
There are two types of IRR: an abbreviated return and a full return. An abbreviated return can provide a simple filing option which allows groups the option to extend to a full return if it becomes beneficial to do so in the future.
In order to file an IRR, a reporting company should be appointed and notice given to HMRC within six months of the end of the group’s relevant period of account, or 31 March 2018 if later. Once appointed, the reporting company is obliged to file an IRR for each period until its appointment is revoked. HMRC may nominate a reporting company where none has been appointed.
Groups potentially affected by the rules that have not yet appointed a reporting company should act quickly to consider whether it is appropriate to do so, obtain the necessary consents and meet the notification deadline.
What approach will groups need to take?
Groups have three main options in relation to the new rules:
- Appoint a reporting company which files a full IRR - For groups that are subject to a restriction for the first affected period, appointing a reporting company simplifies the administration and allows the group flexibility in how any restriction is allocated. A full IRR is also necessary to reactivate amounts of previously disallowed tax-interest in future periods.
- Appoint a reporting company which files an abbreviated IRR - This may be prudent where no restriction arises in the first period, but the group suspects that it may face a restriction in a later period. Where a restriction does occur in the future, the group can replace the abbreviated IRR with a full IRR to carry forward unused interest allowance up to five years.
- Do nothing - If no interest restriction arises in the first period and is unlikely to arise in future periods (eg because total net annual UK tax-interest expense in the group is below £2m and is expected to remain so for the next five years), there may be no need to do anything.
The Government’s tax information and impact note estimates that these measures will only affect a minority of businesses. However, with the Exchequer anticipating tax revenues of £4bn over the next four years from these measures, the consequences to those affected could be significant. Given the complexity of the rules, coupled with the tight timescales noted above, groups that have yet to assess their position under the CIR rules should start considering their position sooner rather than later.
For more information please get in touch with Michael Plant, or your usual RSM contact.