New UK restriction on corporate interest tax relief

Out-Law Legal Update | 05 Jun 2017 | 10:16 am | 8 min. read

LEGAL UPDATE: From 1 April 2017, companies are likely to be subject to a restriction on the UK tax deductions available for interest payments. The latest version of the legislation was in the Finance Bill, but was removed after the general election announcement. 

For updated guidance on the corporate interest restriction see UK restriction on corporate interest tax relief.

It is expected that new rules restricting tax deductions for corporate interest payments will apply from 1 April 2017, even though the announcement of the June UK general election has delayed the passing of the necessary law. The draft legislation was included in the version of the  Finance Bill 2017 which was published in March 2017. However, following the decision to hold a general election on 8 June 2017, the new rules were removed from the final version of the bill,  which became law at the end of April 2017. 

The rules are detailed and complex and so this update provides only a brief outline. It is based on the Finance Bill legislation published on 20 March and the draft HMRC guidance issued on 31 March 2017 – both of which could change.

In the parliamentary debate on the Finance Bill, the financial secretary to the treasury said that a Conservative government would legislate for the provisions removed from the bill, "at the earliest opportunity, at the start of the new Parliament”. Irrespective of the outcome of the election, it is likely that the provisions will be enacted this year and the expectation is that they will still take effect from 1 April 2017.

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 will be 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 will 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.

Earlier drafts of the legislation provided that a third party loan guaranteed by a related party would constitute related party debt, which would have resulted in many commercial loans being ineligible to be used as part of the GRR. However, following extensive lobbying from industry, the draft legislation has been revised and now provides that 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 now 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 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 less than 50 years and not being considered a structured finance arrangement. Buildings that are sublet are included in the definition. 

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 and certain non-financial guarantees, relating to providing the service, will now be ignored.

Although the new restrictions will apply to interest on existing loans, limited 'grandfathering', where existing arrangements are taken outside the scope of the new rules, will be available for 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.

For more information on how the PIE will impact on real estate transactions see our update on the implications of the interest restriction for real estate.


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.

Companies can elect to complete an abbreviated interest restriction return if they are not subject to an interest restriction under the rules, such as those within the £2m de minimis.  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. 

Groups need to appoint a reporting company to make the return.  This is a company that is not dormant and was a UK group company, or a group member subject to UK corporation tax for at least part of the relevant period to which the return relates. 

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 will unwittingly affect genuine commercial transactions.  As with much UK tax legislation, the rules are very complicated and can be difficult to navigate. 

Eloise Walker, Heather Self and John Christian are corporate tax experts at Pinsent Masons, the law firm behind