Latest draft legislation on interest restriction more helpful for infrastructure and real estate, says expert

The draft legislation is contained in the Finance Bill which was published on 20 March.

Eloise Walker of Pinsent Masons, the law firm behind Out-law.com, said: "It is a relief to see HMRC listening to industry lobbying to alleviate some of the more aggravating aspects of the proposed rules. The extension of the public infrastructure exemption to certain real estate companies will be especially welcome, although other sectors may well wonder why the infrastructure and real estate sectors are getting preferential treatment."

A new 'fixed ratio' rule is being introduced from 1 April to limit the tax relief available for companies in respect of interest payments. Tax relief for interest will be limited to 30% of profits chargeable to corporation tax, excluding interest, capital allowances, tax amortisation and relief for losses. There will be a de minimis allowance for groups of £2 million a year. An alternative group ratio rule based on the net interest to EBITDA ratio for the worldwide group is intended to help groups with high external gearing for genuine commercial purposes.

The rules include a 'public infrastructure exemption' designed to take infrastructure projects and certain real estate projects, out of the interest deduction restriction. To qualify, a company’s income and assets must be referable to activities related to 'public infrastructure assets', be fully taxable in the UK and the company must make an election.

Any physical asset may be 'public infrastructure asset' if it meets a 'public benefit test'. That is, the asset is procured by a relevant public body or its use is or could be regulated by an infrastructure authority.  This includes bodies regulating airports, harbours, utility companies, the environment, roads and rail.

Any building may be a 'qualifying infrastructure asset' if it is part of a UK property business and intended to be let on  a 'short-term basis' to persons who are not related parties. 'Short-term basis' means having an effective duration of less than 50 years and not being considered a structured finance arrangement.

In the previous draft of the legislation, companies had to satisfy a 'comparative debt' condition to fall within the public infrastructure exemption. This condition has now been removed. It would have required a comparison between the level of indebtedness of companies qualifying for the public benefit infrastructure exemption with that of non-qualifying group companies, including those outside the UK.

Walker said there had been concerns about whether this would be a one-off or continuous comparison and how the comparison would work in practice since it is difficult to compare projects in different countries given markets are very different and the pricing of debt may be different for purely commercial reasons.

The public infrastructure exemption will only apply to interest paid to third parties where the recourse of the creditor is limited to the income, assets, shares or debt issued by a qualifying infrastructure company. Guarantees from parent companies or non-infrastructure companies within the group could prevent the exemption from applying.

Changes to the draft legislation mean that guarantees provided before 1 April 2017 and certain non-financial guarantees will now be ignored. 

The Finance Bill legislation contains new provisions which set out how the public infrastructure exemption will apply in relation to joint venture companies and partnerships. There had been concerns that the exemption did not work as intended if, as commonly occurs, infrastructure projects were structured as limited liability partnerships or if a qualifying infrastructure company was involved in a joint venture with an investor who was not. 

The Finance Bill will probably not be in final form until the summer as it needs to pass through the parliamentary process and can still be amended. However, the interest deduction restrictions are due to apply from 1 April. 

Walker said: "The speed with which the rules are coming in is, as everyone in the market agrees, somewhat crazy. The legislation has already gone through three re-drafts of certain aspects since the original draft was published in December, and there may well be more changes coming through due to lobbying as it passes through the committee stages."

"With only 10 days to go before it goes live, and no sign of the promised guidance yet, everyone will be struggling to work out exactly what the new rules mean and whether they need to re-structure their debt profile or not. Given the complexity of the calculations, the need to get to grips with the new rules as soon as possible and the small size of many tax teams in even large corporate groups, these rules are proving to be a major headache for corporates," she said.

An 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.