HMRC publishes consultation on restricting interest deductions for corporation tax
Back in February we raised questions about HMRC’s proposals to consult on restricting the rights of large companies to claim a tax deduction for their interest costs. HMRC has now issued its formal consultation paper, asking for responses by 4 August.
The topic follows on from the OECD’s framework discussions to reduce tax avoidance by multi-national companies. Unlike a number of other countries, at present the UK generally allows a tax deduction for all interest on borrowings to support the business activities of a company. There are two principal areas of concern for tax policy makers – the advantage given to highly geared companies from tax relief on interest compared with the absence of tax relief for returns on equity; and arbitrage benefits for multi-national groups generating intra group cross border interest.
The headline message from the consultation is that, from April 2017, net tax deductions for interest will be limited to 30% of EBITDA (calculated under CT rules); there will be no restriction where the net interest expense is no more than £2m pa. There is also an exclusion for “public benefit infrastructure” entities.
The finance charge element of finance lease rentals will count as interest under these rules, as will costs associated with the raising of finance. For lessors, unless the portfolio is being run down, there should be an excess of finance lease “interest income” over the related funding costs, and hence no restriction under these proposals. Correspondingly, for lessees, the impact in respect of finance leases should be broadly similar to purchases financed by borrowings.
The position in respect of operating leases is more complex. From the lessee’s point of view, there is no “interest” or “depreciation” in the rental, so the impact differs from a financed purchase or a finance lease. For the lessor there is rental income rather than “interest”, but there is an interest cost (from financing the business) and depreciation. Many lessors will find their net interest costs to be well below 30% of tax-EBITDA at present. However, modelling indicates that lessors with high RVs could exceed that threshold and that the interest/ EBITDA ratio generally increases as market interest rates increase. Hence these proposals carry a real threat for lessors of certain categories of equipment, particularly as interest rates recover from current levels.
I would encourage lessors to look at the potential impact on their business, including sensitivity analysis with higher interest rates, and consider responding (either directly to HMRC or through the industry associations) before the consultation closes. Of course the analysis is made more complicated by the shadow of the other tax consultation on leasing due to be published during the summer.
To discuss the implications of these proposals for your business, please contact:-
Invigors EMEA LLP
+44 7730 987286