KPMG’s BEPS team brings you regular insights, updates and opinion on all matters concerning the UK’s implementation of BEPS Action 4.
KPMG’s BEPS team brings you regular insights, updates and opinion on all matters concerning the UK’s implementation of BEPS Action 4.Hosted by Daniel Head, Tax Partner, we will be keeping you updated on all the latest developments in relation to the UK’s proposed new regime for the deduction of corporate interest expense. We will be considering issues arising from the drafting and implementing of the legislation as well as the implications for specific industry sectors. If you would like to receive regular updates on BEPS Action 4, please subscribe to Tax Matters Digest. You can also access the diary archive here, if you would like to see more insights.
The UK’s new corporate interest restriction rules took effect from 1 April 2017, and will, broadly speaking, limit a group’s UK tax deductions for its net interest expense to the lower of a percentage of the UK tax EBITDA, taken from the tax computations, and a measure of the net group interest expense, taken from the group accounts. While we would recommend that businesses consider the implications of these rules, it is recognised that their application, in practice, can be extremely complicated. The devil is very much in the detail, and with that in mind, we have produced a series of articles looking at the detail of the rules in ‘bite sized chunks’. These articles can be found below.
The UK’s corporate interest restriction regime applies from 1 April, and draft guidance and regulations have now been published
Debt cap when applying the fixed ratio method.
We look at two elections which adjust the group ratio method calculation.
Related parties aspects of the group ratio method provisions
This article looks at the rules surrounding the public benefit infrastructure exemption for certain non-related party debt.
Commencement and transitional provisions of the new CIR regime.
How do you identify the ultimate parent and the worldwide group?
The next article in our series looks at some issues linked to the CIR group
Administrative requirements of the new regime.
This week’s article looks at more of the administrative requirements of the new regime.
Interaction of the CIR rules with M&A transaction considerations.
This week’s article continues our look at the interaction of the CIR rules with M&A transaction considerations.
This article looks at how the regime applies to derivative contracts.
CIR regime interaction with the new rules on loss relief.
This week’s article looks at how quarterly instalment payments of corporation tax may be impacted by the new CIR rules.
This week’s article looks at the treatment of amounts carried forward under the CIR regime.
Treatment of leases.
This week’s article looks at the regime anti-avoidance rule.
Potential impacts of the new regime on banking groups.
Potential impacts of the new regime on insurance groups.
This week’s article looks at some potential impacts of the new regime on charities.
This article looks at the treatment under the CIR rules of amounts recognised in respect of intangible fixed assets.
The potential regime impact on controlled foreign companies
This article looks at ‘normal’ UK resident companies investing in UK real estate and the pros and cons of applying the public infrastructure exemption.
This week we consider the position of UK and non-UK resident companies holding UK real estate as an investment property and earning rental income.
Application of the CIR rules to real estate investment trusts.
How do the CIR rules apply to corporate JVs?
This week we look at the CIR rules as they apply to JVs structured as partnerships.
This week we look at the implications of the CIR regime for property trading companies.
On Friday 1 December 2017, the government published a draft Finance Bill 2018, including certain amendments to the CIR rules.
The amendments essentially implement the changes announced at the Autumn Budget, which were summarised in our previous diary entry.
In terms of further clarification regarding specific changes previously announced in the Budget Notice.
The CIR rules were finally enacted on 16th November 2017, with retrospective effect from 1st April 2017. However, on 22 November 2017, as part of the Autumn Budget 2017, the Government announced that, following further engagement with affected businesses, various amendments will be made to the enacted legislation to ensure the CIR rules work as intended.
Read our full article here.
On 4 August HMRC published a second tranche of draft guidance on the new Corporate Interest Restriction (CIR). It reflects the updated legislation published on 13 July. HMRC have requested comments by 31 October 2017.
The updated draft guidance has been expanded to include guidance on:
Various other amendments have been made to reflect changes made in the revised draft legislation published on 13th July 2017.
On 13th July 2017, the government confirmed that the Corporate Interest Restriction (“CIR”) rules will be included in a Finance Bill to be introduced as soon as possible after Parliament's summer recess and will continue to have a start date of 1 April 2017.
The government also published a revised draft of the CIR legislation. The fundamental structure of the rules remains unchanged. The amendments made are mostly to (i) fix minor errors, (ii) clarify the intended effect of the legislation, (iii) tighten certain existing definitions / conditions and/or (iv) address policy concerns that have been raised with HMRC in consultation.
There remain some issues with the way that the rules operate in certain scenarios that have been raised with the government in consultation, but which remain unaddressed in the revised legislation. For example:
On 28 June 2017, we held a webinar to discuss the latest position on the draft Corporate Interest Restriction legislation and practical issues that businesses should be thinking about.
The recording can be accessed here, and a copy of the slides here. In this Tax Diary update, we answer the questions put to us during the webinar which we believe will be of interest to the wider audience. If you have any further questions or comments please get in touch and we will be happy to help.
Please note that the answers provided to the questions below are based on the draft legislation contained in the original Finance Bill published on 20th March 2017 and draft HMRC guidance published on 31 March 2017. They are general in nature and not tailored to any particular circumstances. Specific tailored advice should always be obtained and the position will need to be reviewed as and when any revised legislation and/or guidance is published.
Q1. Do the rules commence for periods starting after April 2017 or spanning April 2017?
A. The latter: the rules apply to groups with a period of account straddling 1 April 2017 (assuming 1 April 2017 is confirmed as the start date). For example, for a 31 December 2017 year end it will be necessary to apportion the figures for the year between the pre- and post-1 April 2017 periods.
Q2. In considering the net interest expense, do non-interest charges which relate to financing (e.g. bank arrangement fees) come into the calculating? Or is it only interest paid?
A. Non-interest amounts would qualify as “tax-interest” to the extent that they give rise to relevant loan relationships debits or credits. Bank arrangement fees would normally qualify as deductible under the loan relationships regime. (See below re fees relating to finance leases and debt factoring.)
Q3. When determining the group’s “aggregate net tax interest expense”, is this worldwide or just UK?
A. The group’s aggregate net tax interest expense is calculated by reference to UK corporation-tax paying group companies only (i.e. group companies that are UK resident or non-resident but operating via a taxable UK branch).
Q4. Is a Defined Benefit Scheme Pension Interest Cost included in calculating tax-interest?
A. Only debits arising from loan relationships, derivative contracts and “relevant arrangements or transactions” (broadly, finance leases, debt factoring and service concessions) are included in calculating tax-interest. On that basis, any “interest cost” recognised in a company’s accounts in respect of its obligations under a defined benefit scheme should not fall within the definition of tax-interest.
Q5. Does tax EBITDA include the addition of net tax interest expense / capital allowances etc. to what is effectively your PCTCT?
A. Broadly speaking, yes. The starting position is the company’s “adjusted corporation tax earnings” which is essentially the company’s PCTCT, but adjusted to take into account current period losses and other amounts that would have been brought into account in determining taxable profits for the period had there been sufficient profits. The following amounts are then excluded from this figure: (i) tax-interest income or expense amounts; (ii) capital allowances or balancing charges; (iii) excluded relevant intangibles debits or credits; (iv) losses surrendered by another company (apart from losses that arose while the company was not part of the group); (v) non-capital losses carried forward or back from another accounting period; and (vi) certain qualifying tax reliefs (e.g. R&D, parent box, qualifying charitable donations). An adjustment is also made to excluded any income to the extent it is effectively exempt from UK tax by virtue of double tax relief.
Q6. What is the interaction of "tax EBITDA" etc with brought forward trading losses please?
A. Per the answer to the previous question, in arriving at a company’s tax-EBITDA for a period, you would add back any non-capital (e.g. trading) losses that have been brought forward to the period.
Q7. When calculating tax EBITDA, does this exclude amortisation of
capitalised project costs?
To the extent such project costs are of a capital nature, they will already be excluded in calculating a trading company’s taxable profits (and therefore, by extension, will already be excluded in calculating the company’s tax-EBITDA). However, any capital allowances claimed in respect of such project costs would need to be excluded. To the extent such project costs are of a revenue nature, they will not be excluded in calculating a trading company’s taxable profits and need not be excluded in calculating the company’s tax-EBITDA. (Note that separate rules apply where costs are capitalised into an intangible fixed asset.)
Q8. Would fees charged in connection with finance lease and debt factoring arrangements qualify as tax interest for purposes of the rules?
A. “Tax interest" includes amounts in respect of the financing costs implicit in amounts payable under a [finance lease or debt factoring arrangement]”. So any fees charged would only be included in tax interest, to the extent they are deductible for corporation tax purposes and form part of the overall financing cost implicit in the arrangement. We understand that the Finance and Leasing Association (FLA) is discussing this with HMRC with a view to clarifying the treatment.
Q9. CFM95260 - Is the reference to “long funding operating leases” intended? CFM95660 mentions finance leases only.
A. Yes. CFM95660 is dealing with tax interest expenses / income. For this purpose, only finance leases are taken into account. CFM95260 is dealing with tax-EBITDA. For this purposes, certain adjustments are made in respect of amounts under finance leases and long funding operating leases.
Q10. How do the rules cater for leasing companies which do not show interest income (as such) in their P&L?
A. There are no specific detailed rules to deal with this – the rules just require you to identify the “amount in respect of the financing income implicit in amounts receivable under the finance lease”.
Q11. How do you define related party for interest purposes?
A. Parties will be related if any one of three conditions is met:
Note that (i) in certain circumstances, rights of other persons will need to be aggregated for the purposes of determining whether parties are related; (ii) there are certain exemptions which deem specific loans or other financing transactions not to be between related parties; and (iii) there are certain deeming provisions which can deem specific loans or other financing transactions to be between related parties (these override the exemptions where relevant).
For further detail on the related party rules, please see our article of 31 May 2017 here.
Interaction with loss relief
Q12. If we have a disallowance in any year, and brought forward losses in an entity, can we effectively swap a company loss asset for a group reactivation asset therefore?
A. Yes, to the extent the relevant loss-making company has net tax-interest expense for the period that can be disallowed and the disallowance generates profits that can be offset by the brought forward losses (taking into account any restrictions imposed by the new rules on loss relief that are also expected to apply from 1 April 2017).
Carry forward and unused interest allowance
Q13. If you fall out of rules due to de minimis, can you still establish unused capacity?
A. Yes if you appoint a reporting company and submit “full” returns for all relevant periods. If a group initially files abbreviated returns and subsequently has a need to access interest allowance there is an extended time limit of up to 60 months for submitting a revised full return. Note that full returns would need to be submitted not only for the period of account when the excess interest allowance arose, but also any intervening periods.
Q14. For interest allowance and the order of offset, do you take the current year before the brought forward amount?
A. Yes, any current year interest allowance must be used in full before
any brought forward interest reactivation can be utilised.
Q15. How are 50:50 Joint Ventures dealt with?
A. If neither JV partner would consolidate the JV under IAS, the JV will
not form part of either JV partner’s worldwide group and would form its own
worldwide group for CIR purposes. Note however that the JV may be able to make an election to “piggy back” off the JV partners’ blended group ratio, if this would give the JV a higher group ratio.
Q16. How do you treat JV's which are not consolidated but appear as a one liner in the consolidated income statement as "share of post-tax profit of joint ventures?
A. First, you need to ask whether the JV would be consolidated under IAS (If IAS is not actually used in the group accounts). If the JV would not be consolidated under IAS, it will not form part of the worldwide group. However, an election can be made to allow the investor group to “look through” a “non-consolidated associate” and include its proportionate share of the JV’s interest expenses and EBITDA when calculating its fixed ratio debt cap, group ratio and group ratio debt cap.
Order of disallowance or reactivation of debits
Q17. CFM95220 and CFM98580 refers to a default order in which different classes of tax-interest are disallowed, which the company can elect to override. CFM98620 refers to a default order in which different classes of tax-interest may be reactivated, which the company can elect to override. Where are these points explained in the draft guidance?
A. There is no substantive guidance on these provisions at present. The relevant draft legislation is at s.377 and s.380 TIOPA. The default order of disallowance/reactivation is:
Q18. Regarding time limits for the interest restriction return, would you have to submit a draft return if not all UK Company tax returns have been submitted by the 12 month date?
A. The draft rules allow a return with estimated numbers to be submitted. However, where any estimates are used, (i) the return must specifically identify these estimates and (ii) the reporting company must notify HMRC if any estimates have not been finalised within 36 months after the end of the period of account (with HMRC having a discretion to permit a late revised return in such cases).
Q19. Does an interest restriction return have to be submitted even if there is no restriction? I.e. a nil return.
A. Draft HMRC guidance confirms that where the group reasonable estimates that the £2m de minimis exemption applies, the group will not need to appoint a reporting company or submit an interest restriction return.
If the group has more than £2m p/a aggregate net tax interest expense but reasonably estimates that it will not suffer a disallowance, it will need to appoint a reporting company and submit an interest restriction return. It will have the option to submit an abbreviated return, although if that approach is taken, the group will not be able to use any excess interest allowance for that period in a later period.
As reported yesterday in both the tax and mainstream press, a number of measures have been dropped from the Finance Bill 2017. This is in order to enable it to pass into law before Parliament closes for business in advance of the General Election.
The measures dropped include the Corporate Interest Restriction (and other key corporation tax measures such as the reform of the loss regime and SSE regime).
So what does this mean for the implementation timetable of the CIR regime? Jane Ellison MP (the Financial Secretary to the Treasury) stated that whilst a number of clauses will not be proceeding, “there has been no policy change” and those measures which are not included in this Bill will be brought forward in a Finance Bill at the first opportunity after the election.
It is therefore our assumption that - assuming the Conservatives remain in Government post-election - the commencement date for the CIR will remain as 1 April 2017, but that we will not see finalised legislation until later in 2017.
Questions of course remain over what the timetable will be for both the finalisation of the legislation, and the associated documents, such as the guidance notes.
On 31 March HMRC published draft guidance on the new Corporate Interest Restriction rules which take effect from 1 April 2017. The announcement states that “This is an initial tranche of guidance, focusing on the core rules and other aspects where guidance has been specifically requested. Further draft guidance will be issued by 31 May 2017.”
FB 2017 made a number of changes to the draft CIR legislation. For more information, please click here. On 31 March an expert KPMG panel will be discussing the implications of the new rules. To register and have your questions answered, please click here.
As flagged in previous Tax Diary posts, one of the points which we raised with HMRC during the consultation period was how the new regime would interact with the tonnage tax regime.
We have now received confirmation from HMRC that it is their intention to exclude tonnage tax profits for the purposes of calculating a company’s Tax-EBITDA and interest allowance. They have stated that this is to ensure that the tonnage ring fence remains intact and will maintain the integrity of the new CIR rules.
Tonnage tax profits are deemed profits which replace the actual relevant shipping profits for tax purposes (see para 4, Sch 22 of FA 2000). The deemed profits are usually very low and so the effect of excluding these tonnage tax profits from tax-EBITDA will be to ensure companies are not allowed to deduct more interest by virtue of tonnage tax activities. There would appear to already be a provision to this effect within the tonnage tax legislation, but by also including this within the CIR legislation, it clarifies the position.
Overall, we would expect the effect of this exclusion from the CIR regime to be limited in its application. However, by clarifying the position, it does arguably simplify the compliance process for those affected (as the finance cost adjustment can be calculated before the CIR calculations, therefore avoiding the need to revisit and adjust the interest restriction).
We have produced the attached document which summarises the implications of the new CIR regime for groups operating in the infrastructure sector. In particular, we consider the Public Benefit Infrastructure Exemption (PBIE). For more information, or if you would like to discuss the impact on your business, please contact Naz Klendjian.
HMRC are continuing to draft and refine the legislation which will introduce the new Corporate Interest Restriction (CIR) regime, from 1 April 2017. The latest draft of the legislation is available here.
In addition to the more formal consultation process, stakeholders (including KPMG) are engaging in an ongoing dialogue to feed in comments and suggestions, for example:
On 6 February, HMRC published guidance on the transfer pricing aspects of cash pooling. This is intended to provide guidance to both taxpayers (and their advisors) and HMRC specialists and client relationship teams.
It has been structured to provide guidance on a full range of issues associated with cash pooling, from its most basic form to some of the more complex issues associated with a substantial cash pool header. For example, it includes commentary on
The new guidance has been subject to a lengthy period of development within HMRC and highlights the fact that HMRC are now more focused than ever on the transfer pricing implications of related party financing transactions. In addition to the new guidance we have also started to see more ‘live’ enquiries from HMRC in relation to cash pooling arrangements and the role of Group treasury entities.
If you have any questions or comments in relation to this guidance or would like to discuss the transfer pricing considerations for cash pooling or Group treasury functions in more detail please contact us.
The much anticipated update to the draft legislation on the new corporate interest restriction was published on 26 January for comments. This new draft legislation supersedes the draft legislation originally published on 5 December 2016 as part of the draft Finance Bill 2017 clauses, and contains information on the remaining elements of the rules.
The update extends the draft legislation to a total of 132 pages and includes the draft legislation for the following key aspects of the new regime:
We are working through the significant amount of detail set out in the draft legislation. However, initial observations are that certain policy changes have been made in response to comments received on the initial draft that was issued in December. These include:
In addition, the Government has clarified that if a group has aggregate net tax-interest income for a period, that amount may then be added to the interest allowance for that period. This will allow the carried forward interest amounts that can potentially be deducted in subsequent periods to be increased by the amount of net tax-interest income.
Consequential amendments to regulations for Authorised Investment Funds, Investment Trust and Securitisation Companies will be published separately in draft for comment.
The Government has requested that any comments on the new draft legislation should be provided by 23 February. KPMG will be providing comments, and if you would like us to include any points on your behalf, please do get in touch with Daniel Head.
On 13 December, we held a webinar to discuss the draft Corporate
Interest Restriction legislation that was published with the draft Finance Bill
in early December. The recording of this, and a copy of the slides can be accessed here.
In this Tax Diary update, we answer the questions put to us during the webinar which we believe will be of interest to the wider audience. If you have any further questions or comments please get in touch and we will be happy to help.
In addition, you will be aware that HMT and HMRC are welcoming comments on the draft legislation, and have requested these are provided by 1 February 2017. KPMG will be submitting a response, and if you have specific points that you would like us to consider as part of our response, please do let us know as soon as possible.
We also note that not all of the draft legislation was released in December and certain key elements of the new rules (operation of the GRR and specific definitions) have not yet been set out in legislation. An update is expected by the end of January 2017 and we would expect a further period of time to provide comments to HMT and HMRC on these updates but this is to be confirmed.
1. How will capitalised interest be treated under the new regime?
It is our understanding that capitalised interest will be included within tax-EBITDA (refer 2.20, Response to the Consultation).
The document sets out the concerns raised in the previous consultation, including the suggestion made by some respondents that capitalised interest should be excluded from the definition of tax-EBITDA. However, the Government’s response is clear: it remains the intention to
include in tax-EBITDA those items which are also included in taxable profit. This would therefore include capitalised interest.
The GRR will however include an optional adjustment for capitalised interest on development property and other items of trading stock (refer 3.9, Response to the Consultation).
2. How will losses surrendered by way of consortium relief be treated under the new regime?
Deductions for consortium relief (and group relief, including the proposed carried forward group relief) from companies within the ‘worldwide group' are excluded for the purposes of calculating tax-EBITDA.
Conversely, if consortium relief is claimed from companies outside of the ‘worldwide group’, it is included for the purposes of calculating tax-EBITDA.
3. How will the proposed changes to the leasing standard interact with the new regime?
At the current time, there have been no specific announcements regarding the interaction of the regime with the new leasing provisions. However, in their Response to the Consultation document (6.12), the government states that it will keep this under review as part of engaging on the treatment of lease payments more generally in advance of the introduction of IFRS 16.
4. Is there any commentary on interaction with tonnage tax finance cost adjustment?
No, neither the draft legislation nor the Response to the Consultation document
comment on tonnage tax. We will include this query in our comments to HMT/HMRC.
5. Is there any benefit to front loading interest charges in the period up to 31 March?
Any company with an accounting period which straddles the commencement date will need to apportion interest between pre-commencement and post-commencement periods. Amounts should be allocated on a time basis, or if this results in an unjust or unreasonable apportionment, amounts should instead be apportioned on a just and reasonable basis (Part 10, Schedule 7 of the draft provisions).
Therefore, it would seem unlikely to be any benefit in front loading, or prepaying, interest charges.
The exception to this may be where the late paid interest rules have applied to historic interest charges. Depending on a group’s fact pattern, there may be a benefit in paying any ‘arm’s length’ accrued but unpaid interest before the new rules commence on 1 April 2017. This would ensure that tax relief can be claimed for these historic arm’s length amounts and remove the risk of further restrictions on historic interest charges as a result of the new rules.
This should be assessed on a case by case basis, depending on the group’s broader fact pattern.
6. Should companies continue to agree ATCAs with HMRC?
This depends on the company’s situation and the desired level of certainty. The new regime is much more prescriptive and mechanical than the current regime so there should be less uncertainty regarding the application of the new rules.
However, it is worth remembering that the new regime will apply after consideration of all other existing tax rules including the transfer pricing rules (the arm’s length provision), unallowable purpose rules, anti-hybrid rules, group mismatch rules and distribution rules. An ATCA would therefore still provide clarity on the application of the transfer pricing rules and therefore the starting position when considering the new interest restriction regime.
HMRC have indicated that they are very much still open to entering into ATCAs where these are desirable for the tax payer.
7. Our group will fall below the £2m de minimis threshold. Will we still need to appoint a “reporting company” and notify HMRC?
It is our understanding that it is only necessary to appoint a reporting company and notify HMRC if the group meets (or exceeds) the £2m de minimis threshold. However, we will confirm this point when we provide comments on the draft legislation later this month.
8. Will the IRR return appear as a supplementary schedule to and be included within the "usual" corporation tax return?
We would expect this to be the case, but again, we will confirm this when we provide comments on the draft legislation later this month.
On Monday 5 December, the Government published draft legislation for the proposed new interest deductibility regime.
This is broadly in line with the proposals set out during the consultation held earlier this year, and the draft legislation sets out the detail for the key principles of the new regime (such as the Fixed Rate Ratio). It also has extensive detail on the administration of the new rules for corporates. There are however a number of outstanding areas, most notably, definitions relating to the Group Ratio Rule and the revised “Public Benefit Infrastructure Exemption” (PBIE). The Government intends to publish the remaining clauses by the end of January 2017.
Our commentary on the draft legislation is now available on our website, here.
Alongside this, a response to the consultation was also published, which set out a summary of the responses received from stakeholders during the Summer 2016 consultation, and the Government’s response. In the absence of complete draft legislation, this document does also provide some helpful indicators as to what we should expect in relation to the remaining clauses – for example, in relation to the PBIE. The consultation response document suggests that the PBIE will be broader in scope than previously proposed, both in terms of the sectors and activities it should cover and in the types of interest (there is expected to be some changes to the definition of related party interest).
A more detailed note on the implications for investment into the Infrastructure Sector can be found here.
Finally, a reminder that we will be holding a webinar on Tuesday 13 December to run through the draft legislation in more detail – please click here to register.
With everyone talking about the US Presidential election this week, we thought we’d keep this post topical with a brief note about last month’s release of finalised regulations by the US Treasury Department that impact the treatment of certain related party debt (the “385 Regulations”). Both the journey to this point and the 385 Regulations themselves are far from straight-forward, and so we will not attempt to provide a detailed examination of the scope and implications; instead we will focus on the headline points and let you know where you can find out more information.
Proposed Regulations were originally issued in April 2016. In the six months between proposal and finalisation, the Proposed Regulations were subject to widespread criticism by business and tax professionals. The US Treasury and the IRS have responded by making significant changes to the Proposed Regulations that significantly reduced the impact of the new rules on US parented multinational groups, such as excluding foreign company issued debt from the scope of the 385 Regulations. Nonetheless, the final 385 Regulations introduce new compliance burdens and potential changes in the treatment of certain related party debt that will largely apply to non-US parented multinational groups.
The 385 Regulations generally apply to certain related party debt due from domestic (i.e. US) corporations and certain partnerships, unless both borrower and lender are within the same US consolidated tax group. In general only debt between a borrow and lender within the same “expanded group” (in which there is a common parent with direct or indirect ownership of 80% of the vote or value of each) is subject to the 385 Regulations.
Subject to certain exceptions, the Documentation Rule imposes contemporaneous documentation requirements on certain related party loans, including written documentation of four indebtedness factors. Failure to meet such documentation requirements will generally result in the reclassification of the debt as equity for US tax purposes. The Documentation Rule applies only to debt issued on or after 01 January 2018.
The definition of “contemporaneous” has been relaxed in the final 385 Regulations as compared to the Proposed Regulations, but still imposes a significant administrative burden on borrowers. Concerns have also been raised in respect of certain types of related party funding, for example, the impact on cash pooling and revolving credit arrangements.
The Recast Rule features two basic operating regimes that reclassify certain US company issued debt to members of the same expanded group as equity – the “General Recast Rule” and the “Funding Rule”.
The “General Recast Rule” targets three basic types of “suspect transactions” – (1) dividends of self-created instruments of indebtedness, (2) purchase of expanded group member stock in exchange for debt of the purchaser, and (3) debt instruments issued as “boot” in an inter-expanded group reorganisation. Subject to certain exceptions, debt to which the 385 Regulations apply will be recharacterized as stock for US tax purposes if issued in one of these suspect transactions.
The “Funding Rule” generally applies to recharacterize debt as equity when the debt is issued in exchange for property (e.g. cash) and the issuer engages in certain identified transactions (“funded transactions”) within a 72-month time-frame (36 months before until 36 months after the date of the funded transaction), unless certain exceptions apply. “Funded transactions could include transactions such as dividend distributions or the purchase of expanded group member stock.
In general, the Recast Rule only applies to debt issued on or after 04 April 2016.
The impact for M&A transactions
While the introduction of new and expanded exceptions have limited the scope of the final 385 Regulations as compared to the earlier Proposed Regulations, the US tax consequences of the final 385 Regulations remain substantial for non-US parented multinational groups. In particular, the introduction of the Funding Rule will be especially relevant for related party debt-funded US sub-group companies engaging in M&A transactions, and close monitoring of the ongoing activities of the US company’s activities will be required to avoid unintended recharacterization of certain debt as equity.
What to do now
If you consider that these new 385 Regulations could apply to your US sub-group, we recommend that you take action now to identify the (potential) impact of the Documentation and Recast Rules, including compiling and maintaining a complete inventory of outstanding intragroup loans between US and non-US expanded group members. Consultation with your tax adviser before engaging in transactions involving related party debt-funded US sub-group companies is also recommended to help understand the recharacterization risk.
KPMG Global Webcast
If you would like to hear more about the Regulations, KPMG Global will be holding a webcast on 30 November 2016 – please click here to register.
For further information and assistance
If you would like further, more detailed information on the 385 Regulations, please visit our KPMG US website here. If you would like to discuss the new 385 Regulations in more detail, our colleagues on our US Tax Desk would be happy to assist – please contact Fred Gander (firstname.lastname@example.org, 020 7311 2046) or your usual KPMG contact.
With summer over and an Autumn Statement date announced, we thought now would be a good time for a brief update on what to look out for in the coming weeks in relation to the UK’s new interest deductibility regime.
Whilst there had been speculation by some that the Brexit vote may have forced a delay to the commencement date of the regime, it is our understanding that this will not be the case.
So, with 1 April 2017 still very much the target, here is a summary of our understanding key dates ahead:
A few additional points to note in relation to the new regime:
Q4: If a Group applies the GRR, how is the resultant interest deduction allocated between UK group companies? Is there flexibility?
A4: There is flexibility on where the interest deductions can be allocated. However, the interest deductions can only be allocated to a company up to its net tax-interest expense. As per the previous question, other legislation regarding interest limitation will also need to be considered.
Q5: Is it expected that a taxpayer could carry forward excess capacity that arises prior to 1 April 2017 for three years? Or will this apply only to capacity arising from implementation of the new rules?
A5: The carry forward of excess capacity will only apply to capacity arising from 1 April 2017 and the commencement of the new rules.
Q6: Where a company has interest expense restricted under the modified debt cap rule, will there be provision to carry forward the unused interest expense, similar to a restriction under the FRR or GRR?
A6: Yes, the mechanics of the modified debt cap rule will be fully incorporated with the main rules, so an amount of restricted interest would be available to be carried forward and used in a further period where there is sufficient interest capacity.
Q7: What, if any, interest restrictions do we need to apply to overseas businesses? Is this dependent on the introduction of OECD rules for individual countries?
A7: The interest deductions that can be taken in other countries will be dependent on the specific rules in that country. The UK is expected to be one of the first countries to implement new rules arising from the recommendations of Action 4 and so it is likely that interest deductions in other countries will not be subject to new legislation at the same time as the UK.
Q8: Which groups is the Public Benefit Project Exclusion (‘PBPE’) expected to apply to?
A8: The PBPE is expected to apply to groups that provide public benefit services where there is no risk of BEPS. Groups electing to use the PBPE must identify eligible projects, the tax-interest expense and tax EBITDA of which would then be excluded from the interest restriction calculation.
The definition of an eligible project is fairly restrictive:
• The project is to provide public benefit services i.e. services which it is government policy to provide for the benefit of the public.
• A public body contractually obliges the operator to provide the services (directly or under licence).
• The project involves the provision, or upgrade, maintenance and operation of infrastructure on a long term basis (at least 10 years), or on a short term basis that the operator/ public body expects to continue indefinitely.
• All project revenues are subject to UK tax.
• At least 80% of the gross revenue of the project is expected to arise from the provision of public benefit services.
Q9: Is the PBPE optional?
A9: Yes, the PBPE is optional and a group must elect to apply it.
Q1: How do the proposed rules interact with other interest limitation rules e.g. anti-hybrid, transfer pricing?
A1: Under the Fixed Ratio Rule (‘FRR’) and Group Ratio Rule (‘GRR’), tax-interest will be limited to a percentage of tax-EBITDA. The amounts that are included within tax-interest are those that are taxable/ deductible after the application of other interest limitation rules including transfer pricing, unallowable purpose, anti-hybrid, group mismatch and distribution rules.
A2: Under the current proposal, the new rules will be introduced on 1 April 2017 and will apply to all amounts of interest and other financing costs that arise after this date e.g. the rules will apply on the basis that groups prepare accounts for two notional periods of account, one ending 31 March 2017, the second starting on 1 April 2017. There are no current plans to retrospectively apply these rules to periods pre 1 April 2017.
However, a key concern is regarding the treatment of late paid interest which carries forward in to the new regime. The current proposal is that ‘late interest’ paid on or after 1 April will fall within the scope of the interest restriction rules.
Q3: Under FRR what happens if a company has made nil profit? No interest deduction allowed until revenues are generated?
A3: As set out in the response to Question 1, these new proposed rules will apply after the application of other interest limitation rules and therefore, for a loss making/ nil revenue entity, the arm’s length test may already act to restrict the deduction of interest for that entity before the application of the new rules is considered.
However, if, under the existing interest limitation rules, a potential deduction may be taken for tax-expense, then as the proposed rules will apply on a UK group by group basis rather than a company by company basis, groups can choose how to allocate any interest restriction between the individual companies. Again this allocation is subject to certain limitations.
Please note that all groups are entitled to deduct up to £2 million of net tax-interest expense per year (provided it can be supported as arm’s length) and this overrides the modified debt cap rule.
Consider the position if there is a loss making entity within a positive EBITDA Group. The Group has analysed the other interest limitation rules to determine net tax-interest expense for the Group, and under the FRR and GRR has determined the quantum of this net tax-interest amount that the UK Group can deduct (taking into consideration the £2 million de minimis). This amount can then be allocated between the UK Group entities, however the arm’s length test etc must again be considered in allocating this to the loss making entity.
Now consider loss making entities in a negative EBITDA Group. As before, the Group has analysed the other interest limitation rules to determine net tax-interest expense for the Group. Under the FRR no deduction will be allowed, however under the GRR, the interest deduction will be restricted to the net qualifying interest expense of the Group (i.e. the actual third party interest expense of the Group) subject to consideration of the £2 million de minimis. Again, the arm’s length test must be considered in allocating this interest deduction to loss making entities within the Group.
The consultation document has raised that in certain circumstances, a reduced EBITDA (as a result of loss makers in the group), or the restriction of net qualifying interest expense (for a negative EBITDA group) may result in interest capacity that can sometimes be excessive compared to UK activity. As such, there may be additional rules put in place to cap the level of deductible interest over and above the restrictions set out above, but these are currently under discussion.
During our recent webinar on 6 July regarding the UK’s proposed introduction of a new interest deductibility regime, a number of questions were raised regarding the definitions of key terms that will be used in the calculation of deductible interest.
We consider that the responses may be of use to a wider audience and so have set these questions out below with our answers.
A1: The proposed definition of the UK Group includes all companies in the group that are within the charge to UK corporation tax, so this includes all UK tax resident entities regardless of their place of incorporation.
Q2: What is the definition of Group EBITDA e.g. would exceptionals be included?
A2: For the purposes of calculating Group EBITDA for the Group Ratio Rule (‘GRR’), the method set out in the consultation document is to add back the “Total Group Interest” and group depreciation and amortisation to a group’s PBT.
This means that there is no add back for non-recurring expense items, and therefore, under the proposed rules, exceptionals would appear to be included in Group EBITDA. This is an area we will seek clarity on through the consultation process, although we expect that this will not be amended as the carry forward rules are designed to accommodate for fluctuations in EBITDA.
Q3: When calculating tax EBITDA for the UK Group, can you include interest income which is being taxed through the CFC finance company regime?
A3: No. HMRC and HMT have put forward the position that as the CFC rules are, in effect, anti-avoidance rules, they are not strictly part of the UK corporation tax charge. Therefore, under the proposals, will not be included in tax EBITDA (please see section 8.58 of the consultation document).
Q4: Do the Fixed Ratio Rule (‘FRR’) and GRR use net or gross interest expense?
A4: The rules apply to ‘net’ tax interest expense i.e. the financing expense amount less the financing income amount.
Tax interest is defined by reference to tax concepts and will apply to interest on all forms of debt, payments economically equivalent to interest, and expenses incurred in connection with the raising of finance. Please note that ‘Tax interest’ is not the same as the P&L interest as the amounts within tax interest are those that are taxable or deductible after the application of existing UK rules, e.g. the current arm’s length test, unallowable purpose rules etc.
Q5: What is ‘unused interest capacity’?
A5: Unused interest capacity is the ‘spare capacity’ of the UK Group and references where a UK group’s interest capacity under the Action 4 tests e.g. 30% of tax EBITDA, is greater than its actual net tax-interest.
This is calculated by subtracting the net tax-interest from the interest limit and the spare capacity can be carried forward for up to three years.
For example, a UK Group has EBITDA of £100, and, under the arm’s length test and FRR, is able to deduct net tax interest of £30. However, the UK Group only has net tax interest of £20. Under the proposed carry forward rules, the UK Group can carry £10 of spare capacity forward three years.
In the next year, the UK Group has EBITDA of £80, and, under the arm’s length test and FRR, is able to deduct net tax interest of £24, however the net tax interest is now £30. Under the proposed rules the Group can use £6 of the carried forward spare capacity to deduct the full £30 in the second year and carry forward £4 of spare capacity.
Q6: Is the deductibility of interest limited to the higher or lower of the amount allowed under the GRR and the modified debt cap rule?
A6: The deductibility of interest is limited to the lower of the amount allowed under the GRR and the modified debt cap rule. However please note that the FRR will apply, unless the Group applies to use the GRR.