What UK tax relief is currently available to offshore companies for financing costs?
Under the non-resident landlord regime, tax relief for interest is generally available in full as it accrues, as long as it is on arm’s length terms and does not exceed the cost of the property asset. This has typically led to overseas companies not having relatively low levels of UK tax liabilities on their rental income.
What happens from 6 April 2020 under corporation tax principles?
Due to the complexity of the UK corporation tax rules, there are a significant number of measures which can restrict the deductibility of interest and other finance costs (including derivative movements, FX, loan amortisation charges etc).
The key measures include:
- Transfer pricing (TP) – similar to the existing income tax rules, disallowances could arise if related party debt is not made on arm’s length terms and/or results in the borrower being overleveraged (i.e. thinly capitalised). As is presently the case, an exercise should be undertaken to quantify any TP adjustment.
- Anti-hybrids – broadly speaking, these rules aim to counteract tax mismatches which, for example, creates a tax deduction for finance costs incurred by the borrower for UK tax purposes, but is either not taxable on the lender, or is allowed another deduction for the same expense, in the local jurisdiction. For the rules to apply, there must be either a hybrid instrument or hybrid entity involved in the arrangement.
- Corporate interest restrictions (CIR) – the CIR rules broadly align the limit of tax relief for finance costs with other jurisdictions (particularly in mainland Europe). While historically, corporation tax relief was generally available without restriction (subject to TP and no tax avoidance / non-commercial motive), the CIR provides for a more mechanical, and arguably objective, approach to calculating tax relief.
- a £2m group de minimis, pro rated for period in them 12 months (i.e. no restriction for interest up to this amount);
- a ‘group ratio’ election, which allows for the computation of the worldwide group’s net interest expense as a percentage of worldwide group EBITDA. If this is greater than the above 30 per cent test result, an election may be made apply the more beneficial result;
- a public benefit infrastructure exemption which certain taxpayers can use to potentially disregard the application of these rules. This exemption may be applicable to certain real estate investors.
- Other anti-avoidance rules – a number of other considerations exist, which tend to consider the intentions and commerciality of particular financing arrangements. As a result, each structure needs to be considered on a case by case basis.
These rules are complex and require detailed consideration of the legislation.
In particular, the rules could impact fund investors who have lent into investment structures. That is, where the fund (or an investing feeder entity above it) is considered to be transparent for UK tax purposes and therefore the investors are taxable on interest received, but the fund is opaque (and therefore not investors are not taxable on the underlying income) in the investor’s territory of residence.
In general, companies (or groups, if there is more than one UK entity) are permitted to deduct “tax-interest” up to a maximum of 30 per cent of their tax-adjusted EBITDA for an accounting period. This is subject to:
There are a number of administrative hurdles to be considered as well. For further details on these and the rules in general, see corporate interest restriction - are you prepared? and corporate interest restriction - impact on UK groups.
In addition, the move to corporation tax may also result in added volatility for real estate investors. For example, the requirement to report accounting result in accordance with IFRS/UK GAAP. For example, movement arising on the fair valuing of derivatives (eg interest rate swaps or FX forward contracts) could result in significant swings in taxable income or losses. Attention should be paid to these.
Where does this leave offshore companies?
The above rules could significantly reduce the tax deductibility of finance costs from those experienced under the current income tax regime as well as increase the administrative burden required to prepare and file a corporation tax return.
As a result, tax liabilities may increase, meaning reduced post-tax returns on rental income.
So what could be done?
An action should be taken now to consider how the rules could impact you and your UK real estate investment companies. We have already assisted a number of non-UK residents on these matters and the proactive approach we take is as follows:
- Detailed review of corporate structures and financing flows to understand how taxpayers could be affected.
- Assist in preparing cash tax models in order to estimate the potential quantum and timing of tax being payable.
- Set out recommendations to potentially mitigate the impact of the 2020 rules.
With the new corporation tax regime being only a little while away, please speak to one our team to discuss your particular circumstances further.