Readers may recall that before Brexit stole the headlines tax avoidance was a front page issue. The chancellor continues with his game of 'whack a mole' trying to tackle tax avoidance as Panama papers, British Dependency headlines and anti-corruption summits spring up to remind him that this is a major public interest and political issue.
One of Mr Osborne’s initiatives is to introduce a rule limiting the amount of relief that corporates can claim for interest deductions. This was announced in the Budget and the Treasury has now published its consultation document on the subject. The rule is, theoretically at least, a straightforward formula-based test to restrict interest relief. Of course nothing in UK tax is simple and the consultation runs to 92 pages with 46 questions.
The new rules are likely to have a significant impact on large corporates particularly those with high borrowings and low profitability. In essence a group will be subject to a limit on corporate interest deductions of 30 per cent of the UK group’s EBITDA, subject to a higher limit depending on the level of the group’s borrowings from third parties. Sectors such as real estate may be particularly badly hit whilst private equity and other business models that typically feature high leverage could also be faced with higher tax liabilities. It is important to highlight some points that have been clarified in the document:
- the rules apply to debt from third parties as well as related parties. This is a significant change from the old 'thin capitalisation' rules;
- the first £2m of interest is exempt from the rules. It is estimated that this will exempt 95 per cent of groups from the rules;
- UK to UK transactions are within the scope of the rules. This could catch out groups who assume that only interest on cross border debt is at risk;
- existing thin capitalisation rules will not be repealed, but the worldwide debt cap rules will;
- grandfathering provisions are likely to be limited which may be a concern to certain groups who are at risk of a disallowance;
- there will be carry forward of excess borrowing capacity and restricted interest. This will soften the impact of the rules but add to complexity;
- separate rules are being developed for the banking and insurance sectors; and
- there is provision in the rules to protect public infrastructure finance.
The good news is that there is a consultation which means that business and the profession have a chance to make their views known on what could be significant tax cost for many corporate groups.
If you would like any more information on this issue please get in touch with Ken Almand or your usual RSM contact.