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

Corporate interest restriction ‘devil is in the detail’ – real estate II

Corporate interest restriction ‘devil is in the detail’

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.

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This is the twenty fifth in our series of articles looking at some of the detail of the new corporate interest restriction (CIR) rules. The CIR legislation was included in Finance (No.2) Bill 2017, published on 8 September, with the start date continuing to be 1 April 2017. This week’s article considers the position of UK and non-UK resident companies holding UK real estate as an investment property and earning rental income (property investment companies). While most property investment companies buy developed properties, some will develop and then lease the property. Such UK property investment companies need to consider the various CIR provisions dealing with capitalised interest. In addition, and in line with an ongoing consultation, non-resident property investment companies, which are currently subject to UK income tax, should be assessing the potential implications if they are brought within the scope of corporation tax.

UK property investment company

A UK tax resident company holding UK property for investment purposes is subject to UK corporation tax on its rental income and is within the CIR rules with effect from 1 April 2017.

As we saw in last week’s article, in some cases, it may be possible for such a company to elect into the special CIR regime for public infrastructure. For the purposes of this article, we assume that the company does not meet the conditions to qualify for that regime or chooses not to elect into it.

Property investment companies will commonly capitalise interest costs into the value of the property. Under the loan relationship rules, any such interest expenses capitalised into the value of an investment property are required to be brought into account for tax purposes in the accounting period when they are capitalised (as opposed to the period when they are written off in the accounts). On that basis, any interest capitalised into the value of investment properties prior to the 1 April 2017 start date, should be outside the scope of the CIR rules.

Key points to note and practical implications

  • During the development phase, when the property does not yield any rental income, but interest is treated as deductible when capitalised, this may result in the property investment generating significant tax-interest expense but no tax-EBITDA, and therefore a potential disallowance of interest. However, such disallowed interest will be carried forward and it may be possible to reactivate it in later periods when the property generates rental income;
  • In practice, the UK property investment company (or its wider CIR group) may have several investment properties at different stages of development, so the wider business may generate sufficient tax-EBITDA to enable the capitalised interest to be allowed in whole or part under either the fixed ratio or group ratio method;
  • A common structure for holding rental properties is through use of LPs, UK LLPs or Jersey property unit trusts (JPUTs). The partners can be a mix of UK corporate and non-resident landlords (NRLs). The LPs/ LLPs currently calculate their profits (including taking account of tax relief for interest costs incurred) under the corporate tax and income tax rules (reflecting the nature of the partners) and allocate those profits to the partners. The LPs and LLPs are also required to file a tax computation with HMRC for information purposes; and
  • Following the introduction of the CIR rules, CIR calculations will need to be carried out by each corporate partner’s group. The UK LP/LLP should consider the practical aspects of how to report the interest disallowance in its tax return as it may not have all the information of its partners to compute the interest disallowance under CIR.

Non-UK property Investment company
A non-UK tax resident company holding UK property for investment purposes is currently subject to UK income tax on its rental income and is therefore not within the CIR rules yet. A consultation is ongoing to bring NRLs within the scope of corporation tax for some sources of income. If this proposal is enacted, the CIR rules will become applicable to such entities as well.

The previous articles in this series can be found here: 

 

For further information please contact:

Ruchi Agarwal

Rob Norris


 

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