Corporate interest restriction ‘devil is in the detail’ | KPMG | UK

Corporate interest restriction ‘devil is in the detail’ – group ratio method and related parties

Corporate interest restriction ‘devil is in the detail’

This week’s article looks at the related parties aspects of the group ratio method provisions.

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This is the fourth of our series of articles looking at some of the detail of the new corporate interest restriction rules, which will apply from 1 April 2017. This article has been updated for changes made in the draft legislation issued on 13 July 2017. 

In last week’s article, we introduced the group ratio method. Under this method, the interest capacity is based, in part, on a group accounts measure of net interest (known as qualifying net group-interest expense). For these purposes, interest like expenses payable to a related party are not included in the qualifying net group-interest expense, thereby reducing the capacity to deduct interest. If the group ratio method is to be used, it will be necessary to self-assess whether the group is paying interest etc. to related parties and, if so, whether any of the exclusions from the related party rules apply.

Related parties general rule

The general rule is that persons are related parties at a time when any of the following three conditions are satisfied:

  • Consolidation condition - The financial results of both persons are comprised, are required to be comprised, or would be comprised but for an exemption, in group accounts prepared under the Companies Act (or an overseas equivalent);
  • Participation condition - A person participates in the management, control or capital of the other within the preceding or following six months (or a third party does so in respect of both of them). The Part 4 TIOPA transfer pricing terms are used here, but not applying the ‘acting together’ provision; and
  • Investment condition - A person has a 25 percent investment in another person (or a person has a 25 percent investment in both).

The test of whether there is a 25 percent investment is widely drawn by reference to possession of voting power, entitlement to proceeds on a disposal of equity in the company, and the entitlement of equity holders to income or assets. Rights of connected persons and persons ‘acting together’ are attributed, so certain private equity partnerships may therefore be caught under these rules.

Exclusions from the related party general rule for specified matters

Persons will not be treated as related under the general rule when any of the following conditions are satisfied but only in respect of a specified financial instrument, as follows:

  • Broadly, at least 50 percent of the same debt is held by unrelated parties (exclusion in relation to a loan relationship only);
  • There is a corporate rescue debt restructuring (exclusion in relation to a financial liability only);
  • A loan is made by a bank in the ordinary course of business which were not aware of the relationship (exclusion for the bank loan only);
  • A loan made by relevant public bodies (exclusion for the loan only); and
  • Finance leases granted before 20 March 2017 (exclusion in relation to the finance lease only).

Related parties only in relation to certain types of funding

There are three further rules which deem persons to be related parties but only in respect of certain types of funding. These are not subject to the exemptions listed above.

A financial liability (e.g. a loan relationship) is deemed to be made between related parties in any of the following circumstances:

  • Where, on or after 1 April 2017, a related party provides a guarantee, indemnity or other financial assistance, the financial liability is treated as being between related parties, but see the exclusions below:
A person is not treated as a related party as a result of a guarantee etc. if any of the following apply:
  • The guarantee etc. is provided before 1 April 2017;
  • The guarantee etc. is provided by a member of the group;
  • The guarantee etc. is a pledge in relation to shares in the ultimate parent of the group or a loan to a member the group; and
  • A non-financial guarantee is provided in respect of obligations to provide goods or services.
  • Where funding is provided by a back to back arrangement between related parties, an otherwise unrelated intermediary is treated as a related party.
  • Where persons have (i) provided funding to a ‘borrower’ which gives rise to a financial liability, (ii) those persons hold shares or voting power in the borrower, (iii) the funding and shares/voting power are held in substantially the same proportion and (iv) the lenders, taken together, have a 25 percent investment in the borrower, the funding is treated as being from a related party.

This is the fourth in our series of articles on the detail of the new corporate interest restriction regime. Our previous articles covered draft guidance and regulations on the regime, the debt cap when applying the fixed ratio method, and elections to adjust the group ratio method calculation.

 

For further information please contact:

Rob Norris

Mark Eaton

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