UK: UK Government Confirms Introduction Of New Cap On Interest Deductibility


In October 2015, the UK government launched a consultation on the introduction of new rules to counteract BEPS (Base Erosion and Profit Shifting) arising from the use of interest payments. The outcome of the consultation was published as part of the Budget in March 2016, at which time the government confirmed that it would be proceeding with the introduction of a structural restriction on interest deductibility.

The new restriction is intended to operate alongside the various transactional-based restrictions already present in the UK tax code (such as the transfer pricing, distributions and unallowable purpose rules), and will apply with effect from April 1, 2017. The new restriction will apply both to external and intra-group debt, so it will not be precluded from applying solely by virtue of the fact that the interest in question accrues on debt advanced by a third party lender.

The UK government is currently consulting on the detailed design of the new restriction, and intends to publish legislation later this year for inclusion in Finance Bill 2017.

The Proposed Restriction

The proposed restriction has the following key features, and will apply on an accounting period-by-accounting period basis:

  • A fixed ratio rule (the FRR), limiting UK tax deductions for net interest to a maximum of 30 percent of a group's tax-adjusted UK EBITDA;
  • An optional group ratio rule (the GRR), which a group can apply in place of the FRR and which allows tax relief for interest to be calculated by reference to the group's net interest to EBITDA ratio;
  • A de minimis rule, whereby the new restriction will not apply to groups whose net UK interest expense does not exceed £2 million in any given accounting period;
  • The ability to carry forward spare borrowing capacity from one accounting period to the next (for up to 3 years), and the ability to carry forward restricted interest indefinitely;
  • A modified worldwide debt cap rule, which will apply in addition to the FRR and/or GRR, and which is intended to ensure that groups with low levels of external debt cannot leverage up their UK operations to the FRR limit; and
  • Targeted anti-avoidance rules aimed at preventing the circumvention of the new restriction.

For groups that are not automatically taken out of the rules by the proposed £2 million de minimis rule, there is likely to be a significant administrative burden involved with familiarizing themselves with the new rule and in identifying the relevant tax-adjusted amounts that have to be taken into account in applying the new rule.

Moreover, there is currently no proposal for existing debts generally to be grandfathered. While the government has indicated a willingness to grandfather some unused interest expenses carried forward from periods before the new rule comes into effect on April 1, 2017, the related principal amount outstanding on existing loans will not be grandfathered.

This means that existing financing arrangements in place as at April 1, 2017, will generally be within the scope of the new rule.


Group concept. The FRR will be applied on a group-wide basis (rather than on a company-by-company basis).

For the purposes of the FRR, the definition of a "group" will be based on accounting concepts: in essence, a group will comprise the "ultimate parent" (generally the top level holding company in a corporate structure), together with all companies that would be consolidated on a line-by-line basis into the consolidated accounts of the ultimate parent.

Definition of interest. The concept of 'interest' is extended by the FRR to comprise all payments that are economically equivalent to interest, as well as expenses incurred in connection with the raising of finance. This means that payments in kind (sometimes referred to as "funding bonds", or "PIK") will have to be taken into account when applying the FRR, as will related payments such as guarantee fees.

However, in applying the FRR it is only the net interest expense position that matters. Financing income amounts (such as interest received) are netted off against financing expense amounts in order to reach a net position: it is only the net position that is in principle subject to the FRR restriction on deductibility. This is likely to be of particular importance to multinational groups with centralized treasury functions, as an FRR that operated by reference to the gross rather than net interest position clearly would have presented serious issues for intra-group treasury activities.

Interaction with other parts of the UK tax code. The FRR is intended to apply after almost all other parts of the UK tax code have been considered. This includes the UK's transfer pricing rules, purpose rules and anti-hybrid rules in particular. This means, for example, that groups still may suffer an FRR-based restriction on interest deductibility, even though HMRC is in agreement that the interest in question has a legitimate commercial purpose, does not give rise to a hybrid mismatch outcome and (based on an Advance Thin Capitalisation Agreement) is arm's length for UK transfer pricing purposes.

In addition, although it had been hoped that the new FRR would result in the repeal of the worldwide debt cap, the UK government has indicated that a modified debt cap rule will continue to apply alongside the new FRR.

The modified debt cap rule is intended to prevent groups that would not otherwise have high levels of external debt from leveraging up their UK operations to the FRR limit. In essence, the rule will "cap" the amount of UK net interest for which a group can obtain tax relief by reference to the net external interest expense of the group.

Carry-forward rules. The government is proposing that interest restricted under the FRR should be eligible for carry-forward to future accounting periods indefinitely. This should mean that if there is sufficient capacity in those future periods, the carried-forward amount should become deductible (and should therefore be eligible for tax relief).

The government is also proposing that unused borrowing capacity (calculated by applying the borrowing limit under the FRR) from one accounting period be eligible for carry-forward for up to three future accounting periods.

These aspects of the rules will be helpful to groups, as they should go some way to mitigating the impact of the new rules on earnings volatility across multiple accounting periods.

However, disappointingly there are no proposals to allow the carry-back to previous accounting periods of interest deductions that are restricted under the new rules, or of unused borrowing capacity (calculated by applying the borrowing limit under the FRR). Moreover, the ability to carry-forward excess interest deductions may ultimately not be of any value in view of separate changes on the carrying-forward of losses (the CFL Rules), which were announced at the Budget in March 2016 and which are expected to come into force on April 1, 2017 too.

The CFL Rules will limit the amount of profit that can be sheltered using carried-forward losses, such that only 50 percent of profits in excess of £5 million can be sheltered. At present, the government intends that:

  • Carried-forward losses from before April 1, 2017, will not be subject to the FRR, but will be affected by the new CFL Rules;
  • Interest that arises on or after April 1, 2017, and that is affected by the FRR will not be subject to the CFL Rules; and
  • Losses arising after the application of the FRR will be subject to the CFL Rules.

Illustration of Effect of the FRR

The following table illustrates the basic effect of the 30 percent FRR rule as proposed by the UK government


Under the GRR, groups can elect to apply a group ratio instead of the fixed ratio that applies under the FRR. The GRR is entirely optional and is expected by the UK government to benefit only a small proportion of groups.

The GRR is aimed at groups that are highly leveraged for commercial reasons, and allows them to obtain tax relief for net interest deductions up to a limit in line with the group's overall position. The government is continuing to consult on whether the GRR should itself be subject to a percentage limitation (more than 30 percent, but less than 100 percent) in order to counter potential abuse.

Generally however, the GRR is a welcome feature of the new rules that should go some way to mitigating their impact on groups whose funding structures do not present BEPS risks.

Summary and Next Steps

The FRR generally will have no grandfathering, and will apply from April 1, 2017. The rule could result in significant restrictions on interest deductibility for certain groups, such as private equity owned portfolio companies where leverage ratios typically run in the 4 to 7 times EBITDA region (and possibly even higher in the early stages of an acquisition).

All groups should therefore be considering the ramifications of these forthcoming changes and the possible need to refinance their existing funding arrangements.

UK Government Confirms Introduction Of New Cap On Interest Deductibility

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.