Expert: arguments for delaying restrictions on interest payments tax relief to intensify following OECD publication

This is likely to increase pressure on the UK government to delay introducing the new restrictions, which are expected to apply from April 2017, according to tax expert Eloise Walker of Pinsent Masons, the law firm behind Out-Law.com.

The OECD has proposed allowing countries flexibility in how they deal with interest payments arising in joint venture transactions, according to a discussion paper published this week. The group ratio rule will form part of the new rules to restrict corporation tax relief on interest payments, and will be based on the net interest to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio for the worldwide group. It is intended to benefit groups structured with high external gearing for genuine commercial purposes. 

The UK government, however, is not proposing to include as much flexibility in its group ratio rule for joint ventures, according to the joint HM Treasury and HM Revenue & Customs (HMRC) consultation document published in May 2016.

"It's bad for British business to have these new rules in the first place - especially when we already have a plethora of anti-avoidance in this area and plenty of tools in HMRC's toolkit to tackle such matters," Walker said. "It goes beyond bad – to the point of insanity - to make these rules (which we don't need in the first place) even more stringent than the OECD proposals."

Both the OECD and the UK proposals envisage that the group ratio will be calculated by dividing the net qualifying group interest expense by the group EBITDA. Broadly, qualifying group interest expense will only include third party interest. In many joint venture structures, interest expenses arising to joint venture companies would not constitute third party interest even where the debt arises directly from third party lenders.

However, countries should be allowed to "adjust net third party interest expense" to include interest expenses of joint venture companies where appropriate, according to the OECD discussion paper. The OECD is accepting comments on the discussion draft until 16 August, with a view to finalising its recommendations by the end of 2016.

The UK's consultation document allows for adjustments to the total level of group interest expense to deal with interest expenses of joint venture companies. However, the consultation document does not deal with debt of joint venture companies that would constitute related party debt under the rules. The UK is currently proposing that interest on all related party debt should be excluded when calculating the total group interest expense. Invariably, this will exclude interest expenses on third party debt in joint venture companies.  

"It was not expected that the UK would introduce tougher restrictions than those recommended by the OECD, given that the government is introducing its own restrictions on interest relief following the OECD's recommendations of October 2015," Walker said. "It was also not expected that the UK would attempt to finalise the new rules before the OECD had finalised its own recommendations," she said

"We've already been told we're not going to have grandfathering (which the OECD report allows)," she said. "Now we're likely – unless HMRC sees reason – to have rules that not only hit third party commercial arrangements (given how wide the definition of related party is) but don't even follow the OECD recommendations on how the group ratio should be calculated."

"It's a bit odd, given the only impetus for implementation in the first place is the UK's political desire to snuggle up to the OECD and appease a media-induced witch-hunt against big business," she said.

It is already expected that the UK government will come under pressure from industry experts to delay introducing the new rules, given the political and economic uncertainty that has followed the UK's vote to leave the EU. The new restrictions are likely to have significant adverse consequences for infrastructure and energy projects, which are heavily geared and whose viability is often reliant on tax relief for interest.    

There have previously been calls to delay the commencement of the new rules. When the proposals were first consulted on in October last year, the government was urged to reconsider the timings to allow businesses adequate time to restructure and limit any unintended adverse consequences of the rules. However, in the May consultation document the government said that early introduction of the restriction would demonstrate the country's "leadership" in implementing the G20 and OECD recommendations. 

"I would urge HMRC and the Treasury to think again on this one, and delay and soften the proposals if they really must still implement them," Walker said. "Being the kings of anti-avoidance and leading the way is all very well, and I'm sure other countries will heap hollow praise on these efforts, but it's a paper crown if you shoot your own industry in the head in the process whilst other, less diligent, countries protect their own interests first."