Out-Law Guide 8 min. read

UK restriction on corporate interest tax relief

A new UK corporate interest tax deduction restriction applies from 1 April 2017. The new restriction increases the compliance burden, with highly geared groups significantly affected. 

Tax relief for interest and certain other financing costs will be limited to the lower of 30% of tax-EBITDA and the adjusted net group-interest expense of the group for the period. An alternative group ratio rule is intended to help groups with high external gearing for genuine commercial purposes. Groups with net interest expense of less then £2m will not be affected. A 'public infrastructure exemption' (PIE) is designed to take infrastructure projects and certain real estate projects, out of the restriction.

The legislation is contained in the Finance (no 2) Act 2017 and applies from 1 April 2017.

The rules are detailed and complex and so this update provides only a brief outline. Background

Prior to April 1, 2017, the UK had generous rules in relation to tax relief on corporate interest payments. Subject to a number of anti-avoidance provisions, interest paid on debt financing was generally deductible from a company's UK corporation tax profits and therefore a company's liability to UK corporation tax was reduced.

The new rules are a response to the recommendations made by the Organisation for Economic Cooperation and Development (OECD) in connection with its base erosion and profit shifting (BEPS) project, designed to reduce tax avoidance by multinationals.

The rules are intended to prevent multinationals from loading up UK companies with high levels of debt to reduce taxable profits, whilst shifting business profits to low tax jurisdictions, such as tax havens, so little or no tax is paid. However, the restriction will catch commercial transactions as well as those with a tax avoidance motive.

The new UK rules

Under the new UK rules, tax relief for interest and certain other financing costs is limited to the lower of:

  • 30% of tax-EBITDA, which will broadly be profits chargeable to corporation tax, excluding interest, tax depreciation such as capital allowances, tax amortisation, relief for losses brought forward or carried back and group relief claimed or surrendered; and
  • the adjusted net group-interest expense of the group for the period – this is the 'modified debt cap' and is designed to ensure that the net interest deduction does not exceed the total net interest expense of the worldwide group.

When applying the 30% rule, groups will generally need to work out the tax-EBITDA of each UK resident member company and each UK permanent establishment, and add them together. The limit on deductible interest will be 30% of that figure.

Groups with a net interest expense of or below £2m will be unaffected by the fixed ratio rule.

A company will be able to carry-forward indefinitely interest expenses that have been restricted under the rule. The carried forward interest may then be treated as a deductible interest expense in a subsequent period if there is sufficient interest capacity in that period. Additionally, if a group has spare interest capacity for an accounting period it will be able to carry this forward and use it as additional interest capacity in subsequent periods, although it will expire after 5 years.

The new restrictions apply to interest on existing loans as well as new loans.

Group ratio rule (GRR)

The new rules include a group ratio rule (GRR). Applying this method, the basic interest allowance is the lower of:

  • the group ratio percentage of the aggregate tax-EBITDA for the worldwide group; and 
  • the group ratio debt cap for the period - this is the qualifying net group-interest expense and excludes amounts arising on financial liabilities owed to related parties and certain other amounts.

Subject to the application of the debt cap, the GRR will allow deductions up to the net interest to EBITDA ratio for the worldwide group, if this exceeds the fixed ratio. This is intended to help groups with high external gearing for genuine commercial purposes, by substituting the GRR for the fixed ratio rule if it gets a better result for the group.

The GRR will be calculated by dividing the net qualifying group interest expense by the group EBITDA. When calculating the GRR, whilst net interest is essentially calculated in the same way as for the fixed ratio rule, the worldwide 'group-EBITDA' is an accounting measure – it broadly equals the consolidated profit before tax of the worldwide group, adjusted for depreciation and net interest.

The GRR will be used as an alternative to the 30% fixed ratio rule.  The amount of deductions available under the GRR will be capped at 100% of tax-EBITDA.

Interest on related party loans, perpetual loans and results dependent loans will not be included in the calculation of the GRR.

A loan will not be treated as having been made by related parties where a guarantee is provided by a member of the debtor’s group, or where financial assistance is only provided in relation to shares in the ultimate parent entity or loans to a member of the group, or where the financial assistance is a non-financial guarantee. Limited 'grandfathering' is also available for guarantees provided prior to 1 April 2017.

Public Infrastructure Exemption (PIE)

To maintain investment in the UK's infrastructure sector, there will be an exclusion for interest paid on public infrastructure projects, known as the Public Infrastructure Exemption (PIE).   Infrastructure projects tend to be highly geared and their viability is often dependent on the availability of debt financing. Without a specific exclusion, many infrastructure projects would not get off the ground due to lack of affordable debt financing and difficulty raising equity finance.

The PIE will only be available if an election is made and will only apply to companies where all or (significantly all) their income and assets relate to activities involving public infrastructure assets.

For this purpose, public infrastructure assets will include:

  • tangible UK infrastructure assets that meet a 'public benefit test'; or
  • buildings that are part of a UK property business and are let on a short-term basis to unrelated parties.

The public infrastructure asset must also have, have had, or be likely to have an expected economic life of at least 10 years, and must be shown in a balance sheet of a member of the group that is fully taxed in the UK.

An asset will meet the public benefit test if it is procured by a relevant public body (such as a government department, local authority or health service body) or will be used in the course of  an activity which is or could be regulated by an 'infrastructure authority'. This second limb should be wide enough to include projects relating to airports, ports, harbours, waste processing, energy, utilities, electric communications, telecoms, road and rail.

Companies will qualify for the exemption if they provide a public infrastructure asset or carry on activities that are ancillary to, or facilitate the provision of a public infrastructure asset.

The exemption will also apply to activities relating to the decommissioning of a public infrastructure asset.

Any building may be a 'qualifying infrastructure asset' if it is part of a UK property business and intended to be let on  a 'short-term basis' to persons who are not related parties. 'Short-term basis' means having an effective duration of 50 years or less and not being considered a structured finance arrangement. Buildings that are sublet on a short term basis are included in the definition, even if the head lease is for a longer period.

The PIE will only apply to interest paid to third parties where the recourse of the creditor is limited to the income, assets, shares or debt issued by a qualifying infrastructure company (not necessarily the borrower).

Guarantees from parent companies or non-infrastructure companies within the group could prevent the exemption from applying. However, guarantees provided before 1 April 2017, later guarantees provided by third parties and certain non-financial guarantees, relating to providing the service, will be ignored.

Although the exemption is normally only available for interest on third party loans, limited 'grandfathering' rules will allow the exemption for interest on loans from related parties, such as shareholders, to  infrastructure companies within the PIE where:

  • loan relationships were entered into on or before 12 May 2016; and
  • where at least 80% of the total value of the company’s future qualifying infrastructure receipts for a period of at least 10 years was highly predictable by reference to certain public contracts.

A transitional provision also applies in the first year to enable groups to restructure to fall within the PIE.

If the PIE election is made, the Tax EBITDA of the relevant company will not count towards group EBITDA. It will not always be advantageous to make the PIE election and groups will need to consider the implications carefully.


The new rules operate by assessing the level of interest in the worldwide group and therefore any restriction on the deductibility of interest cannot be processed through a company's normal UK corporation tax return.  UK companies will now need to file a new interest restriction return.

The return contains basic information about the composition of the worldwide group, the key figures from the group interest level computation and the allocations of any disallowances. Groups need to appoint a reporting company to make the return. 

Companies can elect to complete an abbreviated interest restriction return if they are not subject to an interest restriction under the rules.  If a company elects to complete the abbreviated interest restriction return it will not be able to use its interest allowance in a later period, although it will have 60 months to revoke its election and submit a full return.

Expected impact of the new interest restriction

Multinational groups can expect to have to undergo a year on year expensive compliance procedure to determine how much of their current UK interest deductions will have become disallowable. There will also be a transitional period of uncertainty in which restructuring may be necessary.

There is an anti avoidance provision, which is designed to counteract arrangements entered into with a main purpose of securing an advantage under the new rules, such as an increased tax deduction. However, there is an exclusion for arrangements entered into in connection with the commencement of the new regime that do no more than eliminate a tax disadvantage that could not originally have been anticipated when that structure was put in place.

The new restrictions could have a significant impact on structuring UK corporate transactions which involve significant levels of debt financing and corporates located in multiple jurisdictions. Although, predominately aimed at preventing aggressive forms of tax avoidance, they can affect genuine commercial transactions.  

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