UK Budget 2016: Tax deductibility of corporate interest expense

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The U.K. Budget 2016 speech and associated Business Tax Roadmap included an important message on the tax deductibility of corporate interest expense.

So, just in case you missed it, both are reproduced below ….

“Today the Financial Secretary and I are publishing a roadmap to make Britain’s business tax system fit for the future.

It will deliver a low tax regime that will attract the multinational businesses we want to see in Britain, but ensure that they pay taxes here too.

And it will level the playing field, which has been tilted against our small firms.

The approach we take is guided by the best practice set out by the OECD, work which Britain called for, Britain paid for and Britain will be among the very first to implement.

First, some multinationals deliberately over-borrow in the UK to fund activities abroad, and then deduct the interest bills against their UK profits.

So from April next year we will restrict interest deductibility for the largest companies at 30% of UK earnings, while making sure firms whose activities justify higher borrowing are protected with a group ratio rule.”

The Roadmap expands on this: 

Tax deductibility of corporate interest expense

2.30 Businesses get tax relief in the UK for interest they incur on borrowing. 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 tax deduction on the interest is offset against UK profits. Groups might also enter into arrangements to claim further tax relief in the other country, as well as in the UK (see chart 2.C below for an example of this). This creates competitive distortions, for example between groups operating internationally and those operating in the domestic market. These arrangements can readily be created within a group with the effect that the intra-group interest far exceeds interest paid to third parties.

2.31 Under Action 4 of the BEPS project, the OECD has recommended an approach to the design of rules to prevent base erosion through the use of interest expense. The government believes the rules set out in the OECD report are an appropriate response to the BEPS issues identified.

2.32 Following a consultation with interested parties on how the OECD recommendations would work in the domestic context, the government will be introducing a restriction on the tax deductibility of corporate interest expense consistent with the OECD recommendations. The new rules will apply from 1 April 2017. This further demonstrates the government’s commitment to align the location of taxable profits with the location of economic activity, and is in line with the UK’s more territorial approach to corporate taxation.

2.33 The UK will be introducing a Fixed Ratio Rule limiting corporation tax deductions for net interest expense to 30% of a group’s UK earnings before interest, tax, depreciation and amortisation (EBITDA). This approach is in line with the rules that exist in several other countries and international best practice addressing profit-shifting through interest. A level of 30% remains sufficient to cover the commercial interest costs arising from UK economic activity for most businesses.

2.34 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 expenses commensurate with their activities.

2.35 There will be a de minimis group threshold of £2 million net of UK interest expense. This will target the rules at large businesses where the greatest BEPS risks lie, and minimise the compliance burden for smaller groups. The threshold is estimated to exclude 95% of groups from the rules.

2.36 The government also 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 address volatility in earnings and interest. Further consultation will be conducted on the detailed design of all aspects of the rules in due course. The government will also continue engaging with the OECD on the design of rules to prevent BEPS involving interest in the banking and insurance sectors.

2.37 There will no longer be a need for a separate worldwide debt cap 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.

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The complete Business Tax Roadmap is here

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One thought on “UK Budget 2016: Tax deductibility of corporate interest expense

    Wilson Bahati Kazi said:
    April 21, 2016 at 7:41 am

    Great piece of work: educative and informative

    Like

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