Rules have been introduced to restrict the extent to which companies can claim tax relief for their finance costs from 1 April 2017. For highly-geared companies in the property industry, these rules mean an increased compliance burden at best, and possibly an absolute increase in corporation tax liabilities.
From 1 April 2017, the amount of a group’s finance costs that are tax deductible is capped at the lower of 30% of the group’s UK tax adjusted EBITDA, or a measure of the group’s worldwide external finance expense. This cap is referred to as the group’s interest capacity. The restriction only applies to finance costs above an annual de minimis of £2m per standalone-company or group.
Where a company suffers an interest restriction, the amount is carried forward. Relief can be claimed in a later period if finance costs fall below the cap, therefore leaving spare capacity. Similarly, spare capacity can be carried forward for five years to use against finance costs of a later period.
For companies in the property industry there are two elections in particular that could improve the tax position. The first is open to any company and is an election to use the group’s own gearing ratio rather than the default 30% when measuring the cap. The second is the public benefit infrastructure election, which can only be made by ‘qualifying companies’ – which can include companies with a rental business where the property is let on a lease of less than 50 years to an unrelated party.
Broadly, the effect of the election is that interest on loans taken out for the qualifying activity are unaffected by the new rules and are therefore fully tax-deductible.
The rules are intended to restrict the tax relief a group gets for its finance costs to a level that is commensurate with its activities in the UK. However, the rules can be extremely complex and it is possible for wholly-UK groups to suffer a restriction.
Even companies with finance costs below £2m will have to undertake some work to establish whether that is the case, and will need to consider whether they should reporting under the rules in order to preserve interest capacity for use in later periods (where their interest costs might be higher).
Companies caught by the rules will have increased tax compliance requirements and those suffering a permanent restriction will see a reduction in overall returns.
What are we doing with our clients?
Smith & Williamson has been helping clients understand how these complex new rules will apply to them, including modelling their impact on current and forecast financial positions.
Although elections such as the one to apply the public benefit infrastructure exemption have been introduced to recognise the commercial reality of capital intensive businesses, they will not always produce a better result. We have therefore spent time considering both whether our clients can make such elections and whether it is beneficial for them to do so.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.