Since the OECD set to work on the BEPS project, HMRC has embraced with gusto many of the ideas proposed. This is demonstrated by recent legislation, enacted both before and after the final report was published by the OECD in October 2015.
HMRC recently confirmed that legislation is intended to be introduced from 1 April 2017, based upon the recommendations of Action 4 (Limiting base erosion involving interest deductions and other financial payments). It considers that this is another appropriate response to prevent the erosion of the tax base and published draft legislation in December 2016 to ‘limit tax deductions for interest expense and other similar financing costs’, where UK net interest expense is above £2m.
In light of the reported uncertainty surround Brexit and the government continuing to state that the UK is very much open for business, it was perhaps surprising that the legislation wasn’t deferred?
Firstly, the legislation is being introduced at a time when the UK currently has the lowest corporate tax rate in the G7. The government has also announced that it will be reducing the corporate tax rate to 17 per cent by April 2020, which could make it the lowest rate in the G20 by a considerable margin. Subsequent to the announcement, certain european finance ministers have gone so far as to suggest the proposed reduction in the rate of corporate tax is to enable the UK to establish itself as a tax haven on the borders of the EU. It is therefore difficult to comprehend that multi-national enterprises (MNEs) would be aiming to maintain or increase the quantum of interest borne by their UK businesses, as they would more likely be looking to increase the proportion of their overall worldwide tax base subject to UK tax.
Secondly, there are already numerous pieces of legislation currently enacted to limit the deductibility of excessive interest charges, some of which overlap with the proposed legislation.
Thirdly, for existing multinational and UK based businesses that have already invested in the UK and have structured their affairs based upon existing UK tax legislation, it should be noted that the current draft legislation has:
(i) no grandfathering provisions; and
(ii) no carve out for third party debt.
The absence of grandfathering provisions may have a huge impact for the construction, real estate and private equity sectors, as these businesses are typically highly geared for commercial reasons. The absence of a carve out for third party debt could be potentially punitive for these sectors, as often such businesses are locked into long term loans and may therefore be subject to hefty exit penalties to re-finance their operations. Surely these are the types of businesses that the government would want to attract and keep in the UK - have their specific commercial circumstances been truly considered?
Is the introduction of the legislation now, therefore, simply a measure to further demonstrate that the UK continues to be a good international citizen that is compliant with international tax standards, so that it can put its best foot forward when it comes to negotiating Brexit?
Assess the impact and identify options
All UK entities with significant borrowings need to be alert to the fact that the legislation will almost certainly be introduced in Finance Act 2017, effective from 1 April 2017. Companies or groups that already have a net interest expense above the £2m de minimis threshold will need to consider these new rules now to establish how they will be impacted and whether mitigation is possible before 1 April 2017.
For more information please get in touch with Suze McDonald, or your usual RSM contact.