UK and International Tax news

Further Consultation On Tax Deductibility Of Corporate Interest Expense

Monday 23rd May 2016

HMRC has recently issued a second consultation document on the detailed policy design and implementation of draft proposals announced following the October 2015 consultation which closed in January 2016.

On 5 October 2015, the OECD published a recommended approach for limiting base erosion involving interest deductions and other financial payments, which was endorsed by G20 leaders. On 22 October 2015, the UK government launched the first consultation, seeking views on the OECD proposals in a UK context.[see our UK Tax News article of 13 November 2015]. That consultation closed on 14 January 2016 and was used to inform the decisions announced at Budget 2016 and the proposals contained in the second consultation which seeks stakeholder input on the detailed design of the new rules, as set out in the condoc, to inform the drafting of the legislation for the Finance Bill 2017.

In general, respondents to the October consultation were not in favour of the UK introducing an interest restriction in line with the OECD proposals. The majority of respondents argued that the UK’s existing rules already provide sufficient protection from BEPS. Many respondents were of the view that the OECD recommendations represented a blunt approach that was disproportionate to the BEPS risk present.

However, the government has decided to introduce rules necessary to tackle BEPS involving interest in line with the OECD recommendations, which were endorsed by G20 finance ministers and similar rules already exist in a number of G7 countries.

With respect to the timing of the introduction of an interest deductibility restriction rule, two thirds of respondents addressed this question and either said the rules should not be introduced earlier than 2018, or that the UK should not implement ahead of its international partners. Some respondents said that the government should wait for the conclusion of further work at the OECD. A later start date was suggested by respondents to limit the potential impact of the rules on the UK’s competitiveness, and to give businesses adequate time to restructure and reorganise before the rules took effect. However, most respondents did want the government’s decision on the proposals to be published as soon as possible to ensure certainty for businesses.

The point was also made by many respondents that a longer discussion period before implementation would allow a lot of the issues to be ironed out before implementation. There were respondents who warned that a new interest restriction could result in double taxation, whereby interest is non-deductible and interest receipt is taxed, especially if countries introduce the rules at different times or with different features.

HMRC has confirmed that it will be introducing a Fixed Ratio Rule limiting a group’s UK tax deductions for net interest expense to 30% of its UK EBITDA, which it says is sufficient to cover the commercial interest costs arising from UK economic activity for most businesses. The rules will apply on a group-by-group rather than a company-by-company basis.

Recognising that some groups may have high external gearing for genuine commercial purposes, the UK will also be implementing a Group Ratio Rule based on the net interest to EBITDA ratio for the worldwide group as recommended in the OECD report. This should enable businesses operating in the UK to continue to obtain deductions for interest commensurate with their activities.

There will be a group de minimis threshold, whereby all groups will be able to deduct net UK interest expense up to £2 million. This will target the rules at large businesses where the greatest BEPS risks lie, and minimise the compliance burden for smaller groups. It is estimated that this threshold will exclude 95% of groups from the rules.

HMRC also intends to introduce rules to ensure that the restriction does not impede the provision of private finance for certain public infrastructure in the UK where there are no material risks of BEPS. It will also introduce rules to ensure that timing differences including volatility in earnings or interest do not result in an unwarranted permanent restriction.

Taking into account further engagement with the OECD and the responses to this consultation, the government will develop rules to prevent BEPS involving interest in the banking and insurance sectors.

HMRC has confirmed that there will no longer be a need for a separate Debt Cap regime and the existing legislation will be repealed. Rules with similar effect will be integrated into the new interest restriction rules, such that a group’s net UK interest deductions cannot exceed the global net third party expense of the group.

This consultation, which  includes 46 questions on design and implementation of the new rules, runs to 4 August 2016.

If you would like more information on the condoc, please contact Keith Rushen on 0207 486 2378.

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