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26.10.2015 02:49 Age: 2 days

UK publishes consultation on restriction to corporate interest tax relief


HM Treasury has published a consultation paper on its plans to restrict the tax deductibility of corporate debt costs.

The aim, according to the Treasury, is to counter 'aggressive' tax avoidance, especially by multinational companies that use cross-border debts to shift taxable profits between jurisdictions. Typically this is done by: placing higher levels of third-party debt in high tax countries; or using intra-group loans to generate interest deductions that are much higher than the group's actual third-party interest expense; or using third party or intra-group financing to fund the generation of tax-exempt income.

The idea for a restriction on debt relief has been inspired by the Organization for Economic Cooperation and Development's (OECD) Base Erosion Profit Shifting (BEPS) initiative. Most OECD countries allow interest expense to be deducted in calculating taxable business profit, but they also have rules to protect against its misuse. Currently, the UK has two main protection mechanisms. One is a transfer pricing rule restricting tax relief for interest to the arm's-length amount, although there is no check on whether the income and assets supporting that interest are themselves taxable. The second is a worldwide debt cap, which acts as a backstop for excessive interest deductions. There are also a number of targeted anti-avoidance rules to supplement the arm's-length test.

Despite this, the Treasury consultation paper says that 'significant planning opportunities can arise from both external and intra-group interest expenses'.

It acknowledges that a new general rule for restricting interest would be a major change to the UK corporate tax regime, requiring 'careful consideration to ensure any new rules work appropriately'.

The new rule is likely to mirror the OECD's own proposal, that a corporate group's net interest relief should be capped at a fixed percentage of its taxable UK profits. The percentage cap would be set somewhere between 10 per cent and 30 per cent, and applied to the EBITDA measure of profits (earnings before interest, taxes, depreciation and amortisation).

Other possibilities include a cap based on worldwide (rather than UK-only) debt/profit ratios, or an 'equity escape' rule comparing tax-adjusted measures of an entity's level of equity and assets to those of its parent group.

The fixed-ratio cap could also be tempered by exemptions such as a de minimis rule, or an exclusion for companies that supply the public sector. There could also be measures to allow carry-forward of disallowed interest expense or unused interest capacity, to protect companies whose profits are highly volatile.

The consultation closes on 14 January 2016, and the measures are unlikely to be introduced before April 2017.

'It is important that any changes are proportionate to the risks identified by the OECD, and do not go beyond what is necessary to prevent avoidance', commented Heather Self, a tax expert at law firm Pinsent Masons.

  • The UK has cut corporation tax rates from 28 per cent in 2010 to 20 per cent in 2015, and it will be reduced further to 19 per cent in 2017 and 18 per cent in 2020.

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UK publishes consultation on restriction to corporate interest tax relief