Is the corporate interest restriction regime still fit for purpose?

16 May 2023

For over a decade until May 2022, the Bank of England base rate had been static below 1%. Over the last year, interest rates have risen dramatically, as the Bank of England tries to control rising inflation. But are businesses ready for it?

In 2017, 67 countries collectively agreed to implement a series of tax laws designed to prevent tax avoidance (under the Organisation for Economic Co-operation and Development’s base erosion and profit shifting agenda). One of these was an agreement to disallow tax deductions for interest where that interest was deemed to be excessive. 

It’s possible for companies to fund their activities with loans rather than through shareholder equity. In some cases, the loans are deemed to be excessive, but, prior to the implementation of specific rules, this behaviour may have been rewarded by allowing a tax deduction for the interest expense.

The international consensus was that businesses should only be allowed a tax deduction for interest up to a certain percentage of their profits. The UK’s interpretation of this was the corporate interest restriction regime. Under this, companies or groups are allowed tax deductions for UK net interest expense either in line with the group’s worldwide net interest expense (if applicable) or, if lower, 30% of their “tax EBITDA”, broadly equivalent to UK taxable profits before interest, equipment and intellectual property deductions.  

The UK’s rules also included a “de minimis” of £2m – any company or group with UK net interest expense below this level did not need to concern themselves with the restriction. However, now that interest rates are rising, many medium and large companies may find themselves within this regime. 

The issue here is that this regime was brought in when profits were relatively high and interest rates very low. Now interest rates are soaring and profits are struggling due to inflationary increases, particularly on fuel and staff costs. Many businesses will find that what used to be a perfectly reasonable level of debt 10 years ago is now caught by an anti-abuse regime.

This problem is not unique to the UK – in fact, the United States has potentially a worse situation in that their adjustment is based on a metric which is profits after fixed asset deductions – essentially penalising businesses that have lots of equipment or intellectual property. 

However, in the UK the issue is compounded due to the very significant increase in the corporation tax rates last month from 19% to 25% - the biggest proportionate jump in the corporation tax rate in UK history. 

With this new economic environment keeping interest high and profits low, perhaps the Treasury needs to look harder at whether the corporate interest restriction regime as drafted is still fit for purpose.