Base Erosion and Profit Shifting

Base Erosion and Profit Shifting (BEPS)

As currently drafted, the BEPS report will affect both groups and individual companies wholly based in the UK.

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The BEPS report issued by the OECD includes a proposal to cap the amount of tax relief that a company can claim on its net interest payments. Companies with net interest payments exceeding a certain percentage of profits are likely to pay more tax.

The main points

If the UK government’s consultation on the OECD report does not modify the OECD recommendations, the provisions will affect all UK companies, regardless of whether they are members of a group or have cross-border transactions. Limited reliefs are proposed but there is no general exemption for charities or organisations operating for the public benefit.

The detail

Since the OECD published its report in February 2013 highlighting the negative impact of BEPS, the world’s major economies have been working together to “rewrite the rules for corporation tax” by reducing aggressive cross-border tax planning. On 15 October 2015, the OECD published its final BEPS proposals, including a 15-point action plan.

Why is this of interest to housing associations? 

Point four of the action plan proposes capping the amount of tax relief that can be claimed on net interest payments made by companies. Under a Fixed Rate Rule (FRR), the tax deduction would be capped at 10% to 30% of a company’s EBITDA*, with the precise rate still to be determined. Although this proposal ostensibly aims to stop companies moving profits from jurisdictions with higher tax rates to those with lower or zero rates, as currently drafted, it will affect both groups and individual companies wholly based in the UK.

Both companies with lending underpinned by real property and trading subsidiaries - which are often pushed towards loan funding rather than share capital by concerns over charity and tax law - are at particular risk of having interest payments disallowed and having to pay additional tax.

For a trading subsidiary, the ability to reduce the resultant tax by paying a gift aid donation would be limited as the taxable profits would be higher than the underlying accounting profits – it would not have sufficient cash or reserves to make the necessary payment. This will further complicate what should be a commercially-driven decision over appropriate funding structures for housing associations groups.

The actual reliefs outlined in the consultation were limited but there are proposals to mitigate the impact on UK-only groups and companies. Some of the options considered in the consultation are as follows: 

  1. An optional second test would compare the company’s position with that of its wider group. The most likely preference is to limit the interest deduction to the higher of the FRR and the group’s ratio of net interest to EBITDA. This would prevent a tax charge arising where the company’s position is aligned with that of the rest of the group.
  2. An exclusion for interest in connection with public benefit projects is being considered but, as currently outlined, this will only cover certain PFI and PPP projects and only to the extent that the interest is paid to third parties.
  3. Companies with low net interest expense could be excluded.
  4. Disallowed interest/interest capacity could be carried forward to limit the effects of fluctuating profits.
  5. Existing arrangements may be allowed to sit outside of the revised rules for a period of time.
  6. Other rules are being considered to address issues affecting particular sectors, such as banking and insurance.

We have made a number of comments in response to the consultation, including:

  • any new legislation should be sufficiently flexible to ensure that there is no impact on situations that offer no opportunity for BEPS;
  • a full exemption for UK-UK transactions should be considered (although the EU anti-discrimination rules are likely to prevent this);
  • possible exclusion of tax-exempt entities from any FRR calculations of group ratio; and
  • a broader definition for groups that operate in the public benefit

What next?

The consultation closed on 14 January 2016 and its updated proposals should be in the UK government’s Business Tax Roadmap, due for publication early in April 2016. If enacted, the proposals will come into effect sometime after 1 April 2017. 

In the meantime, we recommend that existing arrangements are reviewed now to identify the potential impact of the new rules and so that appropriate action can be taken if necessary.

A second round of consultation remains a possibility and those affected should be ready to make representations.

 

*EBITDA – Earnings before Interest, Taxes, Depreciation and Amortization

 

 

 

 

 

© 2016 KPMG IFRG Limited is a UK company, limited by guarantee. All rights reserved. KPMG IFRG Limited, registered in England No 5253019. Registered office: 15 Canada Square, London, E14 5GL, UK.

This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.

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