Companies urged to help shape UK's approach to interest tax deductibility reform

HM Revenue and Customs (HMRC) intends to include new rules on interest deductions, which will be based on 'best practices' identified by the Organisation for Economic Co-operation and Development (OECD),  in a future "business tax roadmap" document. It has published a high-level consultation document seeking views on the topic, but does not intend to make any changes before 1 April 2017 in order to give businesses "sufficient time to adapt".

Heather Self, a tax expert at Pinsent Masons, the law firm behind Out-Law.com, said: “This is a very brief consultation document, which merely summarises the OECD proposals and asks for views. While it is good that HMT are asking for early input to shape their response to the OECD, it is disappointing that there is no recognition of the UK’s substantial infrastructure pipeline and the impact which any change to interest relief could have”.

In his foreword to the consultation paper, financial secretary David Gauke said that new rules, applied consistently worldwide, would "have the benefit of certainty for business as well as ensuring a more level playing field".

"The government believes that the new rules on interest deductibility as set out in the OECD report are an appropriate response to the [base erosion and profit shifting] issues identified therein," he said.

The consultation closes on 14 January 2016.

The OECD has been working on recommendations for reform of international tax rules to prevent base erosion and profit shifting (BEPS) by multinational companies on the instruction of the G20 group of leading global economies. BEPS refers to multinational corporate groups shifting profits to low tax jurisdictions and exploiting mis-matches between different tax systems so that little or no tax is paid.

Tackling interest deductibility was one of 15 points identified by the OECD in its 'action plan' of July 2013, and the tax cooperation body published its final recommendations earlier this month. Unlike some of the other recommendations produced by the OECD, its report on interest does not set out minimum standards. It has instead recommended that countries introduce a minimum interest/EBITDA ratio of between 10% and 30% into their own tax systems. EBITDA means a company's earnings before interest, taxes, depreciation and amortisation.

In its consultation on how best to implement this recommendation, HMRC said that the UK would be required to introduce a general rule for restricting interest in order to meet the OECD recommendations. The UK currently has a range of anti-avoidance provisions that can restrict deductibility in specific situations, but no general ratio rule. Germany, Greece, Italy and other countries already limit interest deductions to 30% of taxable EBITDA while France has a 25% limit.

"The government recognises that this would be a major change to the UK corporate tax regime and will require careful consideration to ensure any new rules work appropriately, including taking into account the beneficial impact of an 18% corporation tax rate," HMRC said in its consultation.

The UK government has not suggested its preferred percentage ratio, and is instead asking respondents to recommend a percentage "within the proposed corridor of 10% to 30%". It is also proposing to implement an alternative 'group ratio rule' for multinational companies, which would allow UK companies to deduct interest provided that the net interest/EBITDA ratio of the worldwide group did not exceed 40%.

HMRC is also seeking views on the design of an optional exclusion from the general limits on interest deductibility, which the OECD has suggested could be used for "large-scale, highly geared" privately owned projects which provide public benefits. This exception could be used, for example, to allow the deduction of interest expenses on third-party loans linked to PFI and PPP projects. However, the OECD has recommended that this exclusion should be "narrowly targeted" and limited to only those projects that meet certain detailed criteria.

Consultation respondents have been asked to provide details of situations in which they would choose to use a public benefit exclusion, whether or not the UK also chooses to adopt a group ratio rule. HMRC has also asked what this exclusion could look like, "taking account of the OECD recommendations".

“The UK has kept its interest deductibility rules under review for a number of years, and the previous Coalition Government has recognised that the current rules are considered by businesses as a competitive advantage of the UK tax system ( see the Corporate Tax Roadmap 2010 – paragraph 3.8)  It is important that any changes are proportionate to the risks identified by the OECD, and do not go beyond what is necessary to prevent avoidance,” said Heather Self.