UK Releases Draft Interest Restriction Rules | KPMG | CA
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UK Releases Draft Interest Restriction Rules

UK Releases Draft Interest Restriction Rules

The UK presented its draft Finance Bill 2017 on December 5, 2016.


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The bill includes draft legislation for measures from the 2016 Budget and Autumn Statement, including new rules that limit corporate interest expense deductions, changes to the Substantial Shareholding Exemption, and new loss-carry-forward restrictions-relief rules.

The closing date for comments on the bill is February 1, 2017 and the final contents will be subject to confirmation in the 2017 budget.

The UK is changing the timing of its budgets. Following 2017's spring budget, the UK will hold its budgets in the autumn, following the release of tax policy consultation summaries and draft legislation in the summer.

Corporate interest expense restrictions
The bill introduces new rules to limit the interest expense deduction that UK companies may claim for tax purposes. These rules are modeled on the OECD's BEPS Action 4, "Limiting Base Erosion Involving Interest Deductions and Other Financial Payments". The new corporate interest restriction will be effective April 1, 2017 and will apply to groups that have net interest expense greater than £2 million.

As announced in the UK's 2016 budget, the rules will apply to limit interest deductions based on the interest capacity of a worldwide group. The amount of deductible interest is calculated under either a Fixed Ratio Rule, which is the default methodology, or a Group Ratio Rule, which is available on an elective basis. The fixed ratio method of computing net interest expense is based on 30% of a group's aggregate tax earnings before interest, taxes, depreciation and amortization (EBITDA). The group ratio method of computing net interest expense is based on the proportion of a group's net third-party interest expense to its worldwide EBITDA. A modified debt cap rule is intended to ensure that the net interest deduction does not exceed the total net interest expense of the worldwide group.

Included in the draft legislation is a Public Benefit Infrastructure Exemption (PBIE) that exempts interest expense incurred by qualifying companies on funds invested in long-term infrastructure projects that benefit the public in general. These rules exclude interest incurred in respect of most related-party debt.

Under this draft legislation, amounts of interest that are restricted in a particular period can be carried forward indefinitely, and unused interest capacity can be carried forward up to five years.

The bill also includes 20 pages of new filing requirements that companies will need to integrate into their systems. Each worldwide group is required to appoint an entity that will be the "reporting company" for the group and must notify the tax authorities of the appointment within six months from the end of the relevant period. The reporting company is required to submit an "interest restriction return" for the group within 12 months from the end of the relevant period. This return will include a prescribed list of information for each UK company covered by the return, and must set out the specific details of the interest restriction calculation and how the restriction has been allocated between UK companies.

The UK says that details of both the Group Ratio Rule and the PBIE will be included in a subsequent draft of the legislation, as well as more specific guidance on how the rules will apply to particular situations such as derivatives, the Patent Box regime and other tax incentives, real estate investment trusts, and the use of joint ventures and securitization vehicles. An updated Finance Bill 2017 is expected in late January.

KPMG observations
With the release of these new interest deductibility rules, the UK is again at the forefront of countries implementing the OECD's BEPS recommendations (as it was for the hybrid mismatch rules). The OECD's Action 4 Report outlined a number of best practices in the design of rules to prevent base erosion through the use of interest expense, but the report contained no minimum standards as part of its recommendations. However, the UK has essentially followed all of the OECD's recommendations in this regard, including the use of a fixed ratio rule and a worldwide group ratio rule. Multinational groups that have UK entities claiming interest expense deductions do not have a lot of time to determine what the impact of these rules will be, given that they are proposed to apply starting April 1, 2017.

Reforms to the substantial shareholding exemption
The bill simplifies the rules surrounding the Substantial Shareholding Exemption, which exempts capital gains realized on qualifying dispositions of shares from corporate tax. For dispositions occurring on or after April 1, 2017:

  • The company making the disposal no longer is required to be a trading company or a member of a trading group 
  • If the disposal is made to an unconnected person, the company that is sold will not be required to be a trading company or a member of a trading group immediately after the disposition 
  • If the shareholding is less than 10%, and the 10% interest was held for a 12 month period within the six years (previously two) prior to the disposal, the disposition is exempt.

For dispositions occurring on or after April 1, 2017 of companies held by qualifying institutional investors:

  • There is no longer a requirement that the company being sold be a trading company or a holding company of a trading sub-group 
  • If 80% or more of the company is held by qualifying institutional investors, any gain/loss will be fully exempt from tax 
  • If between 25% and 80% is held by a qualifying investor, a proportionate exemption will apply 
  • Where a 10% minimum is not met, the substantial shareholding requirement has been extended to acquisitions with a cost of at least £50 million.

Loss relief
The bill imposes restrictions on the amount of losses that can be carried forward and applied to profits arising on or after April 1, 2017, as proposed by the 2016 UK budget. The rules restrict the amount of losses that can be carried forward in each period to 50% of group profits in excess of £5 million.

However, the bill reforms the corporate-loss carry-forward rules originally set out in the 2016 UK budget to give companies more flexibility by:

  • Allowing group losses arising on or after April 1, 2017 to be carried forward and used against profits from other types of activities 
  • Removing the requirement to apply losses arising before April 1, 2017, before losses arising on or after April 1, 2017.

For more information, contact your KPMG adviser.

Information is current to January 17, 2017. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500

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