Out-Law News | 06 Dec 2016 | 11:17 am | 4 min. read
Clauses to be included in the 2017 Finance Bill, which have now been published in draft, set out how the rules will operate in the majority of cases, including when companies leave and join corporate groups. Commencement, transitional and anti-avoidance rules are also included. However a number of provisions, including the wording and extent of an exemption from the new rules for infrastructure projects deemed to be in the public interest, will not be published until January.
Tax expert Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said that this timetable was "very short notice for such major amendments to UK tax legislation".
"Most businesses and other professionals who responded to the consultation asked the government to slow down, particularly in view of Brexit," she said. "Those pleas have been ignored, and the legislation will come into force on 1 April 2017 as planned."
"The key concerns relate to infrastructure projects, where tax policy seems to be pulling in a different direction from the government's broader strategy of accelerating investment. Many such projects have a high level of debt, without posing a real risk of 'base erosion' or 'profit shifting' (BEPS), and yet they are to be brought within this complex new regime," she said.
"It remains to be seen whether the limited changes announced today, including a wider exemption for public projects and some limited grandfathering for existing debt, will be enough to allay the fears of businesses in this sector," she said.
From 1 April 2017, the existing debt cap rules will be repealed and replaced by a new 'fixed ratio' rule, limiting tax deductions for interest expense and similar financing costs to 30% of 'tax-EBITDA'. This refers to 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. A 'group ratio', based on the net interest expense to EBITDA ratio for the worldwide group, may be substituted for the 30% figure. Corporate groups with net interest expenses below a 'de minimis' allowance of £2 million per annum will be exempt from the new rules.
The restriction is being introduced following recommendations made by the Organisation for Economic Cooperation and Development (OECD) in October 2015, as part of its BEPS project to combat international tax avoidance by multinationals. The rules are expected to have significant unintended adverse consequences for infrastructure and energy projects that are heavily 'geared', with relatively high levels of debt in comparison to the project's equity capital; and whose viability is often reliant on tax relief for interest.
The government is proposing to introduce a 'public benefit infrastructure exemption' (PBIE) as part of the new rules, which "recognises that certain loans used to fund public benefit infrastructure present little risk of BEPS but may nevertheless result in interest expenses in excess of the amount deductible under the Fixed and Group Ratio Rules". This exemption is wider than the pubic benefit projects exemption originally proposed by the government. The exemption will apply on a company by company basis, with 'qualifying' companies fully excluded from their group's interest restriction calculations, with the exception of any non-qualifying interest expense. 'Qualifying' companies refers to those which do not generate operating income other than from qualifying activities; that have no income other than from qualifying projects; and that do not hold any fixed or financial assets other than those representing public benefit infrastructure. "Immaterial" amounts of non-qualifying income and assets will be permitted under the rules.
Qualifying activities will be the provision, upgrade or maintenance of public benefit infrastructure and the undertaking of public benefit services or integral services using that infrastructure. 'Public benefit infrastructure' will be physical objects used to deliver a public benefit service that will have, or will be part of a structure that will have an expected economic life at inception exceeding 10 years.'Public benefit' is used to refer to those services procured by a public body or its wholly owned subsidiary, or provided as a consequence of specific arrangements made by parliament. In both cases, these services must have been procured to "ensure universal provision to the relevant part of the general public". The definition may also refer to services performed in the interest of national security, and to the provision of rental property to unrelated parties, according to the government's response to its consultation.
Interest expense will only be excluded from the group's interest restriction calculation if paid by a qualifying company to a lender which is not a "related party", and which only has recourse to the income or assets of a qualifying company, according to the response. It will not qualify if paid on loans for which guarantees are provided, unless that guarantee is provided by a qualifying company or public body. The PBIE will only exempt interest on loans that are used in their entirety to fund taxable public benefit infrastructure, and which arise from a commercial decision by the owners of the infrastructure to obtain debt finance.
The government has proposed limited 'grandfathering' for projects where the loan was agreed before 12 May 2016, the date on which it published its detailed proposals for the interest restriction rules. The grandfathering provisions will be limited to cases in which 80% of the qualifying company's expected income has been "materially fixed" for 10 years or more by long-term contracts with, or procured by, public bodies or their wholly owned subsidiaries, according to its response.