Latest thinking on Worldwide Debt Cap - Mazars - United Kingdom
Latest thinking on Worldwide Debt Cap
HMRC have announced changes to draft proposals that will restrict the amount of tax deductible interest expense of companies that are members of a large group. The proposals are wide ranging and potentially affect all groups that are funded by debt.
Whilst the changes announced address some of the concerns raised during the consultation process, many groups will fall within these highly complex rules and will need to address their impact when making treasury decisions. Further changes must be anticipated and no announcement has yet been made on the commencement date, other than to rule out 1 April 2009.
The proposed debt cap will restrict UK tax relief for finance expense with the aim of preventing groups putting a greater amount of debt into the UK part of the group than the group has borrowed as a whole. Although simple in concept, the proposed rules in the draft legislation for calculating any potential disallowance are complex. This is in part driven by the requirement that the rules do not discriminate against companies that are resident in other member states of the EU.
The complexity of the proposals is such that we would recommend individual consideration of the group's circumstances. Whilst the changes to the proposals have removed a number of the previously identified difficulties many still remain. Further changes may be announced in the Budget on 22 April.
The technical changes and the main practical effects of the changed approach are as follows:
- In a radical change, the “tested amount” will now be the total of the company by company net finance expense of UK resident members of the group. The netting of finance income and finance expense on a company by company basis, and inclusion of both external and intra group finance income and expense in the tested amount are very different from the previous proposal.
- UK members with net finance income will be treated as having nil finance expense, that is there will be no netting off between group companies.
- Foreign exchange gains and losses are now excluded which should reduce complexity in applying the rules and unexpected results that might have arisen.
- Other changes have been made to the definition of finance income, generally to reduce its scope.
- Short term finance expense and income can be excluded. This will be expense and income on debt with a term of less than a year, and fluctuating repayable on demand facilities, although this may add to the compliance burden.
- The “available amount” will now be the gross external finance expense of the worldwide consolidated group. The same rules for finance income as above will be used to compute the finance expense for this purpose. Previously, the available amount was to be the net interest expense of the worldwide group. If accounting standards require capitalisation of interest expense in the consolidated accounts, this capitalised interest will be included in the available amount.
- As before, the disallowed expense will be the excess of the tested amount over the available amount. This can be allocated by the group amongst companies with net finance expenses, but in a change, the amount allocated now cannot exceed that company’s own net finance expense.
- Again, as before, the amount disallowed will entitle the group to specify an equivalent amount of finance income to be disregarded. Companies that can have disregarded finance income will now only be those members of the group with net finance income, and the allocation to a company cannot exceed that company’s net finance income.
New points of note are:
- An important new addition to the proposed rules that has been announced is a “gateway” test. When a group passes the gateway test it will not suffer any restriction of interest expense due to the debt cap, and it will not have to prepare the debt cap calculations. The “gateway” is passed when the net debt of the UK resident members of the group is less than 75% of the group’s worldwide gross debt. However, the gateway test is limited in its application: for instance it is unlikely to exempt wholly UK groups with intra group debt from the rules.
- Companies with a low amount of finance expense or finance income will be excluded from the group total of the tested amount and available income for the debt cap, although the de minimis level has not yet been announced.
- The company-by-company netting should alleviate the problems previously identified in applying the proposals to group finance and treasury companies.
- Where an adjustment will result in stranded loan relationship debits or excess management expenses, by election the loan relationships giving rise to the stranded tax relief may be disregarded completely.
- Financial statements may be drawn up under IAS, UK, US, Canadian, Japanese, Indian Chinese or Korean GAAP and any other GAAP that is not “materially different” from IAS as regards its treatment of finance expense. This is a welcome revision to the original proposals.
- Anti avoidance provisions in the previous draft legislation are to be replaced by a targeted anti-avoidance rule. This will negate the effect of arrangements where the purpose, or one of the main purposes, of arrangements is to decrease the tested amount, increase the available amount, or decrease the debt taken into account for the new gateway test.
- Financial services groups are to be excluded from the debt cap rules. HMRC have accepted that the proposed legislation would be unworkable. They may have another attempt to produce legislation to bring financial services groups into the debt cap rules.
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