New limitation on tax deductions for interest in the UK
02 February 2017
The UK’s draft Finance Bill 2017, published in early December 2016, is of particular interest to the Treasury community in the UK. It contains detailed draft legislation to introduce a new limitation on the deductibility of interest costs from corporate profits for companies doing business in the UK.
Since these changes will take effect for amounts accruing after 1 April 2017, it is imperative that if they are not already doing so, Treasurers should work closely with their tax and finance colleagues to understand the effects on their company.
What has changed and why does it matter?
The new rules limit a UK group’s ability to deduct interest from taxable profit to the lower of:
- A defined percentage of taxable EBITDA (i.e. Earnings before Interest, Taxation, Depreciation and Amortisation). This will be either 30% or a percentage based on the group’s worldwide interest/EBITDA ratio; and
- The worldwide consolidated net interest expense of the group
There is limited flexibility to carry forward disallowed interest (or excess capacity) for relief in other periods, but this will only apply to certain companies. For many, these new rules will significantly restrict the offset of interest expense against taxable profits. In many cases, there will be additional cash tax payable, and this cost could effectively increase the cost of capital for the business and increase net debt.
What actions should the Treasurer take?
Companies operating in the UK should consider the effect of these rules and develop a management strategy as a matter of urgency, given the limited time before they come into effect.
Some business may be able to mitigate the impact by reorganisation of their activities, and by the use of the carry forward rules. There are also special rules for companies engaged in ‘public benefit infrastructure’ projects, Real Estate Investment Trusts and charities.
Even if there is no permanent disallowance of interest expense, many groups will have to deal with timing differences caused by fluctuations in taxable EBITDA, interest expense, and other variables. It will be important to establish whether the carry-forward mechanisms will give effective relief in future years. This is particularly critical where groups have losses, as new restrictions on the use of historic losses against current profits may mean that some groups are paying cash tax much sooner than they expect.
Obviously the ongoing activities will be dependent upon the potential effect on the company, but from an operational point of view the Treasury and Tax teams should consider putting in place mechanism to calculate the effect on regular basis.
For more information on evaluating the impact of these rules, feel free to contact us or you can also visit our web page.
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