This week’s article looks at some potential impacts of the new regime on banking groups.
This is the nineteenth in our series of articles looking at some of the detail of the new corporate interest restriction (CIR) rules. Ministers have confirmed that the CIR legislation will be included in a Finance Bill, to be introduced as soon as possible after the summer recess, with the start date continuing to be 1 April 2017. Despite industry lobbying, the draft legislation published by the previous Government did not contain any formal exemption for banking groups, but did, however, contain a number of rules particularly aimed at the banking sector. It is anticipated that the effect of these rules will in many cases be that banking groups do not face a restriction (as they will be regarded as having net interest income), but they will still face an additional UK filing obligation and the need to ensure appropriate systems are in place to deal with this.
Looking beyond their own tax position, banks will also increasingly need to take account of the CIR in assessing the ability of highly leveraged borrowers to meet their obligations, especially given the lack of any proposed ‘grandfathering’.
The UK approach
Following consultation, the Government concluded that there should be no financial services exemption from the CIR. This approach had been in line with a discussion draft on BEPS Action 2, but the OECD has since revised its recommendations, acknowledging that an exemption may be appropriate. It is not yet clear whether other countries will provide a financial services exemption as they implement Action 2, but if they do then the UK’s less friendly regime risks being seen as an outlier.
Although calls from industry for a financial services exemption have to date been rejected by the Government, there has been some recognition of the practical difficulties in applying the regime to banks. This has manifested itself in a number of modifications to the rules when these are applied in a banking context.
When applied in a banking context, the rules have two important modifications to the usual criteria for identifying interest.
The first is designed to ensure that the return on Tier 2 or Additional Tier 1 regulatory capital instruments is treated as interest for the purposes of calculating a group’s ‘group-interest’ (which mirrors the way such instruments are generally treated for UK tax purposes and therefore for purposes of calculating a group’s ‘tax-interest’).
The second modification is to extend the definition of interest (both for purposes of calculating ‘tax-interest’ and ‘group interest’) to include amounts arising directly from dealing in financial instruments (other than impairment losses or the reversal of impairment losses).
For some banks this could mean that all income apart from pure fee income may be treated as interest income for CIR purposes. If the UK banking business is profitable, therefore, it is likely to also be treated as net interest positive. Conversely, however, there is a risk that where the bank makes a loss in the UK, some or all of that loss may be regarded as net interest expense. Unless similarly loss making as a global group, the bank globally would typically still have net interest income and so in this scenario the ‘modified debt cap’ provisions could bite to restrict relief for the UK net ‘interest’ cost.
Another effect of this second modification can be to bring back into the rules amounts which are explicitly excluded from the standard definition of interest. In some cases this may simplify the calculations required. Importantly, however, impairment losses continue to be excluded from the definition of interest, reducing the chance of relief for these being restricted.
For many banks the key practical impact of the CIR regime will be the associated compliance burden, which can involve a number of complexities. For example, the inclusion of dealing profits and losses within interest only applies to ‘banking companies’, and so groups will need to make sure that the correct concept of interest is applied to banking and non-banking group companies.
The compliance burden can also be mitigated to some extent by opting to file abbreviated returns, although this comes at the cost of losing the ability to carry forward excess interest capacity. It also remains necessary to have appropriate procedures in place to support the abbreviated return.
The previous articles in this series can be found here.
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