This guide provides a basic outline of the worldwide debt cap' rules. The rules are complex and you should take tax advice before taking any action based on the contents of this guide.
Companies that are subject to UK corporation tax generally get tax deductions for interest payments and other outgoings in relation to loans, in accordance with the way those payments are treated for accounting purposes. This is subject to various anti avoidance provisions and special rules for connected companies.
The rules on the taxation of overseas source dividends were reformed with effect from 1 July 2009 so that overseas source dividends received on ordinary shares and most non-ordinary shares are now largely exempt from UK tax. The "worldwide debt cap" was introduced to restrict the generous tax deductions for financing expenses given by the UK, in order to pay for the more favourable treatment of dividends.
The objective of the "worldwide debt cap" (debt cap) is to restrict corporation tax deductions for interest and other finance expenses claimed by members of a large group, by reference to the group's consolidated finance costs.
The debt cap rules apply for periods of account beginning on or after 1 January 2010.
In May 2016, the UK government announced its intention to repeal the debt cap rules following the introduction of a new rule restricting the ability of a company to deduct interest expenses from its taxable profits. The new interest deductibility rule is expected to be introduced from April 2017 and will restrict tax deductions for interest by reference to a fixed ratio constituting a percentage of a company's earnings before interest, taxes, depreciation and amortization (EBITDA).
The government currently intends to integrate rules with a similar effect to the debt cap into the new interest deductibility rule, such that a group's net UK interest deductions cannot exceed the global net third party expense of the group.
Which companies do the rules apply to?
The debt cap rules apply to large groups of companies. A group will be large if at least one member has at least 250 members of staff, an annual turnover of at least EUR50 million, and/or a balance sheet total (gross assets) of at least EUR43 million.
The rules look at the position of the "worldwide group", which is a large group which contains at least one "relevant group company".
A company is a "relevant group company" if it is resident in the UK or carrying on a trade in the UK through a UK permanent establishment and is the ultimate parent of the worldwide group or a 75% subsidiary of the ultimate parent. In addition to owning at least 75% of the shares of the subsidiary (either directly or through other group companies), the ultimate parent must be beneficially entitled to at least 75% of any profits available for distribution to the subsidiary's equity holders and to at least 75% of the assets available for distribution to the equity holders on a winding up.
The gateway test
The debt cap rules will only apply if the "gateway test" is satisfied. This is satisfied if the "UK net debt" of the worldwide group exceeds 75% of the "worldwide gross debt" of that group. If the test is not satisfied the debt cap rules will not apply.
To calculate the "UK net debt" of the group you need to calculate the "net debt amount" of each relevant group company (those that are resident in the UK or carrying on a trade in the UK through a UK permanent establishment).
To do this you add together, as at the first day in the worldwide group's period of account (start date), all of the company's overdrafts and other borrowings, its liabilities in respect of finance leases and all its financial liabilities that produce a return that is economically equivalent to interest and that have a minimum term of 12 months.
You then subtract from this, as at the start date, cash and "cash equivalents", amounts loaned by the company, net investments in finance leases, government securities and all of the company's financial assets that produce a return that is economically equivalent to interest (and that have a minimum term of 12 months).
This is the company's "start date net debt". You then carry out the same calculation as at the last day in the worldwide group's period of account (end date) to arrive at the company's "end date net debt". You must then take the average of the company's start date net debt and its end date net debt to arrive at the company's "net debt amount". If this is less than £3 million, it is deemed to be nil.
You then calculate the worldwide gross debt of a group by calculating the group's "relevant liabilities" as at the day before the first day of the relevant period of account and as at the last day of that period, and take an average of the two.
A group's "relevant liabilities" are all of the group's overdrafts and other borrowings, its liabilities in respect of finance leases and all of the company's financial liabilities that produce a return that is economically equivalent to interest and that have a minimum term of 12 months.
If the "UK net debt" exceeds 75% of the "worldwide gross debt" of the group, the gateway test is satisfied and deductions may be disallowed.
Disallowance of deductions
If the gateway is satisfied it is then necessary to look at the detailed rules to ascertain the amount (if any) of the corporation tax deduction that will be disallowed.
The basic rule is that if the "tested expense amount" (broadly, the net financing costs of relevant group companies) exceeds the "available amount" (broadly, the gross financing costs of the worldwide group) for any period of account of the worldwide group, the excess UK financing costs are disallowed.
If a group has suffered a disallowance of deductions it may be entitled to exemption from corporation tax up to the same amount. The group can decide which of its UK group companies should benefit from this exemption.
If one company benefits from the exemption from corporation tax, but another company suffers the disallowance, a payment (balancing payment) made to the company that suffers the disallowance by the company that benefits from the exemption will not be taken into account for corporation tax purposes, provided certain conditions are satisfied.
The debt cap rules do not apply to a group which is a "qualifying financial services group". This exception is designed for banks, insurance companies and other financial institutions.
There are special rules for group treasury companies.