27 May 2016

Restriction on interest deduction – Will the Ring Fence be affected?

CW-Energy-2

From 1 April 2017 new rules will restrict interest deductions for the larger UK groups. Although HMRC has agreed that ring fence interest deductions are not to be impacted by these rules, the level of ring fence deduction within a group may impact the level of restriction for non ring fence deductions. There is still time to make representations on how the new rules will operate.

  • The second consultation document was published on 12 May
  • It seeks views on the operation of a new measure to restrict the tax deductibility of corporate interest expense
  • The current proposal is to restrict the level of deductible interest for non ring fence activities
  • For groups with a mix of ring fence and non ring fence activities there are options to calculate this restriction
  • The consultation closes on 4 August 2016.

If you think the new rules could affect your business and you would like to understand more details please get in touch.

Here’s the detail with comments from your CW Energy experts:

The government published a second consultation document on 12 May seeking views on a new measure announced in the Chancellor’s Budget on 16 March 2016 on a restriction on the tax deductibility of corporate interest expense. The government is planning to introduce the restriction in Finance Bill 2017 with the new rules to apply from 1 April 2017.

This comes as a response to OECD’s recommendation (Action 4) arising from their work on the Base Erosion and Profit shifting (BEPS) conducted by G20 leaders to tackle the shifting of profits from jurisdictions where such profits have been earned to lower tax jurisdictions and claiming excessive tax deductions in higher tax jurisdictions. In particular, the UK government is concerned that some multinational groups borrow more in the UK than they need for their UK activities, for example because the funds are used for activities in other countries which are not taxed by the UK.

The rules will replace the existing World Wide Debt Cap rules.

How the restriction will operate

The proposal is to restrict an interest deduction to 30% of the group’s tax-EBITDA (which is essentially profits chargeable to corporation tax before interest, depreciation & amortisation in tax terms as defined in the document, and losses & group reliefs). The restricted interest can however be carried forward indefinitely.

Where it is accepted that a group has a high external gearing for genuine commercial reasons, the 30% restriction will be replaced by the Group Ratio which is based on a worldwide group calculation which could lead to a higher proportion of interest allowed for tax deduction (limited to the actual interest expense). There are certain proposals to limit an excessive interest deduction in cases where the group ratio is very high.

There is a de-minimis group threshold of £2m of net UK interest expense.

Our comment: 

Whilst it is understandable that the governments are concerned about the erosion of profits from higher tax jurisdictions, some industries maybe highly leveraged due to the nature of activities. Such industries would include capital intensive sectors such as infrastructure projects and oil and gas sector. As such it would seem unfair to apply the restriction across the board.

Effect on Ring Fence Oil & Gas companies

Under the current proposal, the new interest restriction rules would only apply to restrict the level of interest which is deductible for non ring fence activities. This exemption has been suggested as a result of profits from exploitation of oil and gas in the UK and UKCS being subject to a special Ring Fence Corporation Tax regime which imposes a higher tax burden and which already prevents taxable profits from oil & gas activities being reduced by losses from other activities or by excessive interest payments.

The government is however exploring options on how the exclusion of ring fence activities from the new rules would impact the restriction of the non-ring fence level of cost of debt.

They have proposed two options. One option, which is the most straightforward, is to exclude ring fence activities entirely from the interest restriction calculation. The government have suggested that this could provide an additional incentive for groups to distort how they allocate debt between ring fence and non ring fence activities. However we would argue that the existing rules which apply to restrict the deduction for interest within the ring fence should act as sufficient protection to ensure that the level of ring fence debt is correct and therefore should not feature in any consideration of the non ring fence position. The second option is to perform an additional calculation for ring fence activities by reference to the whole group. This undoubtedly would add a greater complexity.

Our comment:

It is currently unclear how the calculation under Option 2 would be applied in practice. One of the main questions is whether the restriction would apply to all interest outside the ring fence activities even in cases when no deduction is claimed within ring fence for debt which is in fact used for funding ring fence but is claimed within non ring fence. It does however seem clear that option 2 would provide a greater complexity and could in fact result in a higher restriction than under option 1.

HM Treasury and HMRC would like to see views of companies with ring fence activities on the proposed options.

The consultation closes on 4 August 2016 and the government expects responses in a form of answers to a number of questions addressed in the consultation document.

Download a copy of the Government Consultation Document

Our comment:

If option 2 is to be avoided we think it is important that representations are made that the existing rules mean that the ring fence interest figures cannot be manipulated.