Tax deductibility of corporate interest expense

HMRC issued a further consultation document on 12 May 2016 concerning proposals to limit tax relief for corporate interest expense. This is a major issue for larger companies and groups which have interest and related financing expenses in excess of the £2 million de minimis per year.

On 12 May 2016, HMRC and HM Treasury issued a further consultation in respect of the tax relief for corporate interest expense – this time covering detailed policy design and implementation issues. The document runs to 92 pages, highlighting the complexity of the proposals. This will be a major issue for UK companies and groups (for these purposes it is the accounting definition of a group that is used albeit that only those within the charge to UK tax that will be directly impacted) with net interest expense of £2 million per annum (the new proposed de minimis) and with the start date of 1 April 2017, there is relatively little time for affected companies to assess their options, especially as we will not see the actual legislation for some time yet. It is important to appreciate that ‘interest expense’ for this purpose is widely defined and includes payments economically equivalent to interest, expenses of raising finance and capitalised interest falling within s320 CTA 2009. However, as the UK Government is a keen advocate of the OECD BEPS project, we can be certain that these measures (stemming from BEPS Action 4) will go ahead. What is of concern is that these rules are being rushed in so quickly, potentially putting the UK at a competitive disadvantage until other countries also implement the OECD proposals. It will, however, add some clarity to the options available (or not available, as the case may be) to those that may be impacted by the proposals regarding hybrid structures (BEPS action point 2) in the Finance Bill 2016, Schedule 10.

Further details are still required as to how these rules will be modified in respect of banks and insurance companies.

Rationale for the interest restriction

The UK has always had relatively attractive rules for interest deductibility, even despite a number of provisions restricting the amount which could be deducted, such as the worldwide debt cap, transfer pricing, loan relationships anti-avoidance rules and anti-hybrid rules. That relatively benign environment has been one of a number of factors which has made the UK an attractive location for multinational enterprises.

However, the OECD identified a number of scenarios under which base erosion and profit shifting could arise, e.g. through groups having high levels of debt in high tax jurisdictions, the use of debt to fund tax exempt activities, and the use of intra-group financing arrangements to increase the tax deductible expenses in excess of the group’s overall third party debt (a situation the UK had already catered for through the worldwide debt cap).


Groups with net interest expense of up to £2 million will not be affected. Groups with net interest in excess of this amount will always be able to deduct this amount regardless of the modified debt cap (see below).

There is also a proposal for a Public Benefit Project Exclusion, which would allow groups to elect to exclude the relevant figures connected with public infrastructure projects from their interest restriction calculations. 

Different measures by which interest expense will be restricted

Ignoring other areas of tax legislation which may operate to restrict interest deductions, there are three different ways in which interest relief may be restricted:

  • Fixed ratio rule – which will restrict relief for net ‘tax-interest’ expense where it exceeds 30% of the group’s ‘tax EBITDA’; or alternatively
  • The optional ‘group ratio rule, which may be more attractive for more highly leveraged groups, and which instead restricts the interest deductions based instead on the ratio of net qualifying group interest expense/ group EBITDA (using accounting figures) instead of the 30% in the fixed ratio rule. 
  • The modified debt cap - the tax deductible interest expense in the UK will be capped at the amount of net qualifying group interest expense.

Fixed Ratio Rule

Tax relief for ‘tax interest’ will be restricted to 30% x tax-EBITDA. Groups can then choose how to allocate the restriction between group members, although the amount allocated to any given company will be limited to its net tax interest expense.

Tax interest

Similar to the worldwide debt cap rules, it is the net financing expense after deducting finance income which is adjusted under this formula – and the finance expense and income amounts concerned are after any adjustments required under transfer pricing, unallowable purpose, group mismatch, anti-hybrid and distribution rules. However, unlike the debt cap rules, it is also necessary to include impairment losses on loan relationships or finance lease receivables, related transactions (e.g. break costs on early termination of loans) and derivative contracts here. For these purposes ‘tax interest’ also includes payments economically equivalent to interest, expenses of raising finance and capitalised interest falling within s320 CTA 2009, and amounts attributed to a corporate partner would also be included. 


If there is a branch profits exemption, amounts relating to the exempt branch would need to be excluded. It is also proposed that exchange differences on the principal itself will be excluded – but there is the obvious promise of anti-avoidance if attempts are made to convert interest expense into exchange losses. (Note that exchange differences on the retranslation of interest and other financing amounts WILL be included in the calculation.)


Tax EBITDA is the company’s profits chargeable to corporation tax (or losses) adjusted to exclude:

  • Tax interest (as defined above);
  • Tax depreciation – capital allowances less any balancing charges
  • Tax amortisation deductible under the intangibles rules (including the fixed 4% where elected for) – excluding amounts for realisations or revaluations where they reverse previously relieved amounts
  • Relief for losses brought forwards or carried back
  • Group relief claimed or surrendered.

As the focus is on chargeable profits, clearly exempt income (e.g. exempt UK dividends) will be excluded.

The consultation document notes the potential for the exclusion of losses brought forward or carried back to impact the fixed ratio result, and ponders the possibility of adding further complexity by requiring groups to carry forward negative tax EBITDA, although thankfully this appears to be one for the back burner for now.

For the avoidance of doubt, Tax EBITDA will include net chargeable gains (after the deduction of any capital losses).

Tax EBITDA will also include any deduction for patent box profits so that interest is only relieved at the appropriate rate, and research and development expenditure credit and land remediation relief will also be excluded. Conversely, the R&D enhanced deduction will be added back, so that any interest restriction does not impact this.

Carry forward of restricted interest

Restricted interest will be carried forward indefinitely, and deductible in a later period as if it were an expense of that period. The interaction of this facility and the proposed restrictions on the use of losses will need to be taken into account.

Carry forward of spare capacity

Spare capacity arises where the net tax interest is lower than the limit calculated under the fixed ratio rule. It will be limited on a company by company basis to the amount of spare capacity a given company has. Net interest income does not generate spare capacity, so it won’t be possible to engineer it. Spare capacity is proposed to only be allowed to be carried forward for three years, to avoid the threat to the Exchequer of large balances accumulating which could ‘lead to distortions in commercial behaviour’. Such distortions will also be countered by having anti-avoidance rules similar to loss-buying rules.

Group ratio rule

The group ratio is: Net qualifying group-interest expense/ Group EBITDA.

The consolidated accounts figures (under acceptable GAAP) will be used. If the group is in a net income position, net group interest will be zero.

Where group EBITDA is zero or negative, the interest limit will simply be the amount of net qualifying group interest expense.

Again, spare capacity could be built up and there are different proposals for dealing with this, which highly geared groups need to consider so appropriate representations can be made, otherwise timing differences may be lost.

Total group interest

The items to be included here would be similar to those for computing the ‘Available Amount’ under the current debt cap rules, but it would not be necessary to consider what the overseas tax treatment of any amounts would be. So total group interest would include items like interest on borrowings, interest on relevant non-lending relationships, losses on borrowings, ancillary expenses, finance lease interest, debt factoring finance, and the financing expense implicit in amounts under a service concession where this is accounted for as a financial liability.  Finance income would mirror these. Exchange differences would be excluded.

Adjustments would then be made for certain items (e.g. capitalised interest would be included) and preference share dividends would be excluded.

Financing costs between ‘related parties’ are to be disregarded – so it will not be possible to boost the group’s interest deductions by using related party debt to increase the deduction above the 30% limit under the fixed ratio rule. The definition of related parties will be wider than merely common control, so an investment of greater than 25% by the one party in the other (or both parties having a common 25% + holder) will apply. Indeed, even persons acting together such that collectively they exceed the 25% threshold will cause associated financing costs to be ignored.


The starting point will be the group’s profit or loss including income from portfolio investments and shares in profits/ losses of associates and joint ventures. However, various adjustments will again be needed for things like group depreciation and amortisation (as with tax EBITDA). Profits or losses of the disposal of subsidiaries or parts of the business will also be included, although adjustments will be needed in the interests of consistency if the profits or losses include amounts in respect of assets which have previously been depreciated, amortised or impaired (as these amounts were themselves added back in the first place).


Finally, the profits and losses from derivative contracts in respect of financing amounts will also be included within the scope of the rules, including fair value movements.  For example, groups can use derivatives to fix interest rates, or to effectively pass finance costs between group companies.