HMRC has announced the second phase of a consultation on the tax deductibility of corporate interest expense, which will look at the detailed policy design and implementation of new rules designed to bring the UK in line with the OECD’s Base Erosion and Profit Shifting (BEPS) project and address aggressive tax planning by multinational companies (MNCs)
Plans to introduce new rules on interest deductibility from 1 April 2017 were announced at Budget 2016, following an earlier consultation which closed in January and sought views on the general principles.
The new rules will limit the tax relief that large multinational enterprises can claim for their interest expenses. In its outline of the detailed proposals, HMRC said the government will introduce a fixed ratio rule to cap the amount of relief for interest to 30% of taxable earnings before interest, depreciation and amortisation (EBITDA) in the UK, or based on the net interest to EBITDA ratio for the worldwide group.
HMRC says this approach is consistent with the approach in several other countries and international best practice. A level of 30% remains 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, so all groups will be able to deduct net UK interest expense up to £2m. HMRC estimates suggest this threshold will exclude 95% of groups from the rules, which it say will mean the rules target large businesses where the greatest BEPS risks lie, and minimise the compliance burden for smaller groups.
The government 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 says the rules will apply to all amounts of interest, other financing costs which are economically equivalent to interest, and expenses incurred in connection with the raising of finance.
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 modified cap will strengthen the new rules and help counter BEPS in groups with low gearing.
The consultation document looks in detail at the workings of each of these options, and contains examples of how the new rules will be applied in a number of different circumstances.
The consultation is open until 4 August and the government will consider responses in the drafting of the legislation for Finance Bill 2017.
David Gauke, financial secretary to the Treasury, said: ‘Due to the importance of this issue, we are publishing this next document now to seek views from all stakeholders on the detailed design of the new rules.’
