UK: Further Restrictions On Interest Deductions For UK Companies?

Last Updated: 23 June 2015
Article by BDO LLP

The UK has a history of providing generous corporation tax reliefs for the payment of interest compared to other OECD countries. With pressure remaining on public finances, interest deductions would be a soft target on which to impose greater restrictions. Danny Alexander, currently Chief Secretary to the Treasury, has revealed that his party is "developing proposals on tax deductibility of interest" for corporate interest payments if the Liberal Democrats are returned to government.

Such developments should be considered against a backdrop of the base erosion and profit shifting (BEPS) process. Action 4 (see Business Edge January 2015) in particular covers the use of interest deductions to shift profits around a worldwide group. Its recommendations may provide further guidance on how tax authorities may seek to restrict interest deductibility to tackle profit shifting activities. Action on hybrid mismatch arrangements may similarly lead to interest payments being disallowed in cases where the recipient treats the income as a non-taxable distribution. Of course, with its new diverted profits tax, this Government has pre-empted the BEPS process once already.

The table below summarises the main restrictions on interest deducibility in each of the UK's major European neighbours. Until 2009, when the UK introduced the worldwide debt cap regime, it had tended to focus primarily on arm's length principles and anti-avoidance measures to restrict interest deductions. Other territories have taken more of a formulaic approach, disallowing either a proportion of net finance expenses or an amount above a percentage of accounting profits. It is possible that the UK may move towards this form of restriction. This would arguably be easier to apply than the more subjective concepts embedded in existing UK tax measures, but would be a significant departure from current practice.

Only time will tell how the UK's regime for interest deductions will change in the future, but a study of practices in other territories provides an overview of possible new approaches.

Rule

United Kingdom

Germany

France

Spain

Restrictions on proportion of net interest expense

 

Aggregated UK tax deductions for interest restricted to consolidated gross finance expense of group (debt cap)

Excess of interest expense over interest income disallowed if exceeds 30% of EBITDA

Only 75% (85% for years ending before 1 January 2014) of net finance expenses deductible where they exceed €3m.

Excess of interest expense over interest income disallowed if exceeds 30% of figure similar to EBITDA

Carry forward rules

 

None, but exemptions for UK companies with corresponding net finance income

Restricted interest can be carried forward indefinitely. Unused EBITDA can be carried forward for up to five years

None

Restricted interest can be carried forward for 18 years (indefinitely from 2015). Unused EBITDA can be carried forward for five years

Exceptions

‐   Only applies to large groups

‐   Gateway test: where UK net debt does not exceed 75% of group's gross worldwide debt, do not need to apply the cap

‐ Excess interest expenses less than €3m per business

‐ Not member of group

‐ Group member but equity at least 2% of total balance sheet assets

None

‐  Excess interest expenses up to €1m pro-rata

‐  Credit institutions, insurance companies, private equity firms etc

Thin capitalisation rules and restrictions on interest paid on bonds etc

Transfer pricing: arm's length pricing applies to loans from related parties, including those 'acting together' in relation to financing arrangements

Interest on loans granted by shareholders or affiliated companies may be deemed distributions to the extent the rate charged exceeds the market rate for a similar loan

Interest to shareholder or related party is only deductible if recipient taxed on it at a rate at least 25% of the French CIT rate. Interest paid to related parties only allowable up to annual average interest rate charged by banks on loans of up to two years.

Further restrictions on related party loans (subject to safe harbour rules), unless actual rate used is demonstrably arm's length

None

Interest on loans taken out to acquire participation in other companies

No restrictions

No restrictions

Generally allowed except where:

‐   Acquisition is between jointly controlled companies and acquirer and acquiree enter into group consolidation, or

‐   Control and management decisions over acquired company not taken by acquiring company

Interest on financing intra-group entity acquisitions not deductible, unless taxpayer can show economic reasons for the transaction

Proposed future changes

Existing unallowable purposes test will be replaced with new anti-avoidance rule to counter arrangements entered into with a main purpose of obtaining a tax advantage. Hybrid mismatch legislation from 1 January 2017

   

For taxable years starting from 1 January 2015:

‐  Deductions disallowed on hybrid instruments where corresponding income not taxed at rate of at least 10%

‐  Interest on intra-group participating loans granted from 20 June 2014 not deductible

‐  Complex restrictions on deduction of interest on loans to purchase shares in a company

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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