The corporate interest restriction (CIR) rules, which are effective from 1 April 2017, introduce complex new restrictions in relation to the tax deductibility of interest and other financing costs.
An outline of the rules, the reporting requirements and certain elections which can potentially be made to reduce any disallowance arising was provided in February’s Tax Voice article.
The rules are wide-ranging and mainly target UK members of worldwide groups. However, they can potentially result in an interest disallowance for groups (and standalone companies) with operations exclusively in the UK, as outlined below.
UK domestic groups
The issue for UK only entities is that the CIR legislation goes beyond the remit of Action 4 of the OECD’s Base Erosion and Profit Shifting (BEPS) project, which provides recommendations for rules to limit tax base erosion involving interest deductions.
As a result, many UK domestic groups (and standalone UK companies) are discovering that they may suffer a restriction of the tax deductibility of their interest expense. This includes companies and groups with ‘plain vanilla’ third party loans and those with arm’s length related party loans that were not the focus of the BEPS project.
Mismatches between accounting and tax measures
One of the main scenarios in which a UK domestic group may suffer a restriction is where there is a mismatch between the treatment of items from a tax and accounting perspective, as set out in the following examples.
Where UK net interest expense exceeds the 30 per cent fixed ratio of tax EBITDA and the group ratio is applied, a mismatch could arise between the way an interest-like expense item is recognised for UK tax purposes and how it is treated in the group accounts.
This could lead to the accounting measure (Adjusted Net Group Interest Expense, or ANGIE) being lower than the equivalent tax measure, which is broadly the aggregate net tax-deductible interest per the UK corporation tax computations.
This could, in turn, result in a disproportionate disallowance of interest under the CIR rules.
There may also be significant differences between ‘Group EBITDA’ (an accounting measure taken from the group’s consolidated financial statements) and Aggregate tax-EBITDA (a tax measure based on the UK tax computations).
A higher Group EBITDA figure will produce a lower ‘group ratio’, meaning that any benefit of making a group ratio election may be reduced.
What can you do?
There are various approaches that UK domestic groups can take to limit the impact of the CIR. These include the following election options:
- Make a group ratio election for a period of account. This is useful for highly leveraged UK groups because it substitutes the group’s own ratio of qualifying net group interest-expense (QNGIE) to group-EBITDA where this is higher than the 30 per cent fixed ratio.
- Make an interest allowance (alternative method of calculation) election. This allows the group to align the calculations of amounts recognised in the group accounts (for example in respect of capitalised interest and employer pension contributions) with the way these items are recognised for UK tax purposes. This could help in the situations outlined in examples 1 and 2 above.
- To the extent any mismatch is just a timing issue, it is possible to make elections to smooth it out over a number of years. For example, disallowed interest can be carried forward indefinitely to reactivate in subsequent periods. Unused interest allowance for an accounting period can also be carried forward for up to five years.
- Companies involved in the provision of public infrastructure or the short-term letting of property may be eligible to elect into the ‘qualifying infrastructure company’ regime, which may reduce the interest restriction in certain circumstances.
To benefit from the above elections, groups will need to appoint a reporting company and make the appropriate election(s), usually within an interest restriction return. This may be an abbreviated return if no restriction arises.
The CIR is an extremely complex regime that calls for specialist professional advice. For more information please get in touch with Michael Plant or your usual RSM contact.