The BPF was commenting in a briefing to members on the latest consultation document published jointly by HMRC and the Treasury which sets out more details of the government's proposals. The interest restriction was one of the recommendations made by the Organisation for Economic Co-Operation and Development (OECD) as part of its base erosion and profit shifting (BEPS) project to prevent tax avoidance by multinationals.
"Real estate is a highly capitalised industry that has historically relied extensively on debt funding. If the tax deductibility of interest is restricted, the cost of using debt funding will increase for real estate investors. The higher an investor’s gearing level, the greater the impact of the measure. Investment in real estate will generally become more expensive, returns to investors will fall and there may be an impact on asset prices across the market," the BPF said.
The new fixed ratio rule will mean that tax relief for interest will be limited to 30% of 'tax-EBITDA'. Tax-EBITDA will 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.
Groups will need to add the tax-EBITDA of each UK resident member company and UK permanent establishment. If the group’s net tax-interest expense exceeds this 30% limit there will be an interest restriction equal to the excess.
The new rules will include a group ratio rule based on the net interest to EBITDA ratio for the worldwide group. This is intended to help groups with high external gearing for genuine commercial purposes.
John Christian, a tax expert at Pinsent Masons, the law firm behind Out-law.com said: "A big concern for the real estate sector is that there is no automatic exemption for third party debt, even though that should, by definition be on arm’s length terms and not give rise to an avoidance problem".
"The group ratio carve out allows a higher than 30% threshold for higher geared businesses, where basically the gearing is from third parties. However, this is not the same as an exemption for third party debt as such and there will be cases which will fall outside the group ratio. It is not clear how the group ratio would work in fund structures and joint ventures, for example," he said.
There will be a de minimis allowance of £2 million per annum which means that groups with net interest expense below this will be unaffected by the fixed ratio rule. The government says that this will exclude 95% of groups from the new rules.
The government is proposing a limited 'public benefit project exclusion' (PBPE), which would enable groups to exclude the eligible tax-interest expense, as well as any tax-interest income and tax-EBITDA connected with suitable projects, from their interest restriction calculation.
In order to qualify for the PBPE, the project would have to "provide services which it is government policy to provide for the benefit of the public" and a public body would have to contractually oblige the operator to provide those services, or license the operator.
Jon Robinson, another tax expert at Pinsent Masons, said: "The PBPE exemption is very restrictive and will only apply to PFI type projects. It had been hoped that the scope of the exemption would be set wide enough to cover projects which deliver a wider public benefit such as social affordable housing."
The government is still considering how the rules should interact with the REIT, PAIF and non-resident landlord regimes.
"The consultation asks for comment on whether and how the regime should apply to non-resident companies which pay income tax rather than corporation tax. It is not surprising that these companies are considered to be within scope," said Robinson.
Despite calls for the introduction of the rules to be delayed, the government intends that the new rules will apply from 1 April 2017 to all corporate borrowers, including those with existing loans.
"The government's willingness to press on with a highly complex regime in a short timeframe and no grandfathering is likely to lead to many unanticipated problems in practice," said John Christian.
Restricted interest will be carried forward indefinitely and may be treated as a deductible interest expense in a subsequent period if there is sufficient interest capacity in that period. In addition, if a group has spare capacity for an accounting period it will be able to carry this forward and use it as additional interest capacity in subsequent periods until it expires after 3 years. The proposed rules do not provide for any ability to carry back excess interest or capacity.
The new rules were the subject of an early stages consultation in October 2015 and the business tax roadmap published with the Budget in March briefly outlined how the rules would operate.
"It is crucial that those in the real estate sector let the government know how the reforms will impact on them by responding to the consultation. Practical examples from real projects are likely to be particularly persuasive," said Christian.
The consultation closes on 4 August.