CIR regime and the implications for M&A transactions | KPMG | UK

M&A Matters - CIR and the implications for M&A transactions

CIR regime and the implications for M&A transactions

Following the publication of the summer Finance Bill, we now have confirmation the corporate interest restriction (“CIR”) regime is due to apply from 1 April 2017 whatever a company’s year-end. In this article, we consider the implications for M&A transactions.

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Key points

  • When modelling post-acquisition cash flows, the impact of the CIR rules on the expected tax relief for financing costs is vital – we recommend that modelling is undertaken early on before the structure is determined – the previously held assumption that bank debt will be fully deductible may no longer be valid (modelling post-acquisition cash flows).
  • The CIR rules operate by reference to a worldwide group which is headed by its ultimate parent – changes to the ultimate parent impact the CIR calculations. (Changes to CIR ultimate parent).
  • If electing to use the group ratio method the deductibility of interest-like expenses will depend in part on group interest from the group accounts and certain interest (i.e. payable to related parties) is excluded which reduces the capacity to deduct interest. (How to apply deductibility of interest-like expenses).

Introduction to the CIR regime

Under the corporate interest restriction (CIR) rules, interest-like expenses are disallowed to the extent that the net finance charge taken from the UK tax computations exceeds the interest capacity.

The interest capacity is based on a percentage of tax-EBITDA (taken from the tax computations) or, if lower, a measure of the net interest expense, based on the group accounts (the debt cap), but is always at least £2 million.

Modelling impact of the CIR rules – new approach required

The approach to modelling post-acquisition cash flows must now take account of the impact of the CIR rules on the expected tax relief for financing costs as, going forwards, modelling will become much more difficult.

The model must take into account the hybrid and other mismatch rules and the interaction with the revised loss utilisation rules. The combination of rules and restrictions is leading to greater complications and we’re seeing old assumptions being thrown out the window.

Identifying the CIR group

The CIR rules operate by reference to the ‘worldwide group’. In particular, the total disallowed amount is computed on a group-wide basis and is then allocated between UK group companies. It is vital to correctly identify the ultimate parent and which entities comprise the worldwide group. Typically this follows the International Accounting Standards (IAS) definition of consolidated subsidiaries. 

Generally speaking, a worldwide group will consist of all entities that would form part of a group applying IAS; broadly, a parent and its consolidated subsidiaries. An IAS parent will only be treated as the ultimate parent if it is a ‘relevant entity’, which is defined as a company or an entity whose shares, or other interests, are listed on a recognised stock exchange and are sufficiently widely held (i.e. no participator holds more than 10 percent by value). The CIR grouping rules mean that a partnership is only capable of being the ultimate parent of a worldwide group if it meets the relevant conditions described above. 

A subsidiary under IAS will not qualify as a CIR subsidiary if the investment in that company is measured at fair value under IAS (as opposed to having its results consolidated on the more normal line-by-line basis). Such a company is excluded from the CIR group of its IAS parent.

For groups which are owned by private equity partnerships, particular care will be required to identify the ultimate parent.

Impact of the CIR rules – utilisation of carried forward amounts

The CIR rules provide for disallowed interest-like expenses and unused allowances to be carried forward to a later period. If there is a change in ownership of a company or group, an assessment is required as to whether these attributes are still available and who can access them.

  • Carried forward interest allowance: Net interest-like expenses for UK companies are deductible to the extent they do not exceed the interest allowance for the current period plus the interest allowances carried forward from earlier periods that have not expired. The unused interest allowance for a period can be carried forward for up to five years and may allow more of the interest-like expenses, which arise in a later period, to be deducted. This is an attribute of the group and not of any particular company in that group. 

- Where a group is acquired, the ‘old’ group ceases and any carried forward interest allowance is lost. Similarly, any carried forward allowance will be lost where a new top holding company is inserted which becomes the ‘new’ ultimate parent of the group, e.g. if a new holding company is added in preparation for an IPO. 

- Where a subsidiary is sold or purchased, they will not be able to take with them any interest allowance from when they were a member of the seller group; instead the seller group will retain the ability to utilise any carried forward interest allowance.

  • Carry forward and reactivation of disallowed interest: Interest-like expenses which have been disallowed are carried forward as an attribute of a company and may be deducted by that company in a later period where there is “headroom” in the amount of the allowable interest. This attribute is carried forward across the sale of the company or a change in the ultimate parent, broadly, provided that the activities of the company continue. The existing change in ownership rules (in Part 14 CTA 2010) and the proposed new loss utilisation rules have not been extended to amounts carried forward under the CIR rules. However, the CIR regime targeted anti-avoidance rule and possibly the transfer of deductions anti-avoidance provisions (in Part 14A CTA 2010) could be relevant.
  • Carry forward of excess debt cap amount: The deductibility of net interest for a period is based, in part, on the debt cap allowance (using figures from the group accounts). Where there is a disallowance in a period and the debt cap is not the limiting factor, the excess debt cap amount can be carried forward and may result in more interest being deducted in a future period. This is carried forward as a group attribute in a similar manner to a carried forward interest allowance. 

It should be noted that whereas a group’s capacity to access relief for current year interest is increased by any unexpired interest allowance carried forward from earlier periods (see above), its capacity to reactivate interest disallowed in prior years only takes account of the current period interest allowance. It is generally unlikely that a group would have both carried forward disallowed interest and a carried forward unused interest allowance but this could arise following an acquisition. For example, where a group with unexpired carried forward interest allowances (and no previous disallowances) acquires a company with carried forward disallowed interest, it will only be possible to reactivate such disallowed interest to the extent that the group has current year excess interest allowance after the acquired company has joined the group. This illustrates the level of detailed understanding of the rules which will be required to model the impact of the acquisition.

Related parties

For each period, a group can elect to calculate the interest allowance based on the group ratio method. Under this method, the interest capacity is based, in part, on a group accounts measure of net interest-like expenses (known as qualifying net group-interest expense). For these purposes, interest-like expenses payable to a related party are not included, thereby reducing the capacity to deduct interest. If the group ratio method is to be used, it will be necessary to assess whether the group is paying interest etc. to related parties. 

For example, bank borrowing can be treated as being from a related party where a guarantee, indemnity or other financial assistance is provided by a related party who is not a member of the group. However, a bank’s security package should not cause them to be treated as a related party in relation to the borrowing, provided the guarantee is only from companies within the group. 

Where a group is owned by private equity partnerships, particular care will be required to identify funding from related parties. 

Changes in composition of the group – interaction with the CIR elections

The CIR rules contain over fifteen possible elections which can mostly be made or amended after the end of a period. Where companies are purchased and sold, it will be necessary to assess the impact of elections on the acquired company or group.

  • Some elections are made for the group. Where a company becomes a member of a new CIR group, any such election will cease to apply to the company and calculations will be based on whether the “new” group has made an election.
  • Alternatively, an election may be made by a company which is unaffected by leaving or joining a group.

Tax Matters Digest “devil is in the detail” series of articles

Further details of the CIR rules are provided in a series of weekly Tax Matters Digest “devil is in the detail” articles which look at aspects of the CIR rules in “bite sized chunks”. Click here to read the articles.

 

For more information please contact:

Rob Norris - Director

Mark Eaton - Director

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