Navigating the Corporate Interest Restriction Landscape
Nathan Sutcliffe · September 19th 2023 · read
Exploring Investment Groups and the Public Infrastructure Exemption
The Corporate Interest Restriction (CIR) involves restricting the tax deductibility of interest for companies. These rules were brought in to reduce the tax advantage of multinational groups parking excessive amounts of debt in the UK. This tax advantage has often been achieved where interest income is received in a low tax jurisdiction but the expense is eligible for a full UK tax deduction.
Under the CIR rules, where a UK standalone company, or group, has a net interest expense of more than £2m, there may be a restriction on the tax deduction received. The net interest expense is broadly calculated by deducting interest expenses from interest income. The £2m can be pro-rated for short periods.
Once over the £2m de minimis, the company’s, or group’s, interest capacity is calculated using either the fixed ratio or group ratio method. The fixed ratio method very broadly takes the lower of 30% tax-EBITDA of the UK group and the worldwide net group expense subject to certain technical adjustments such as capitalised interest (fixed ratio debt cap).
The group ratio is more complex and replaces the 30% above with the group ratio percentage, which is broadly the net external interest of the worldwide group divided by the EBITDA of the worldwide group. This is then instead compared to the group’s net worldwide third-party interest expense. When dealing with a wider non-UK group, the group ratio could yield a more favourable outcome.
It is always recommended to compare the two calculations to determine which gives the greatest deductibility. If there is a restriction, the disallowed interest can be carried forward to future years and ‘reactivated’ (giving the company the interest deduction at that point) although in practice this can be challenging.
What are Investment entities?
The starting point for the CIR calculation is identifying the worldwide group. A worldwide group is an ultimate parent and all its consolidated subsidiaries. Broadly, an ultimate parent will not be a consolidated subsidiary of an entity which is an ultimate parent itself.
Where an entity is required to measure its investments using fair-value accounting, some subsidiaries may be non-consolidated. This is most likely where the parent is considered an ‘investment entity’ under IFRS 10 and as such:
- There are multiple, usually unrelated, investors,
- There is usually more than one investment,
- The business purpose is to invest funds solely for capital gains and/or investment income, and
- The performance of investments are measured on a fair-value basis.
Where a subsidiary is measured using fair-value accounting, it is not consolidated into the parent company’s accounts and therefore not part of the worldwide group. Therefore, this entity can become the ultimate parent of its own worldwide group. The CIR planning point here is that more than one worldwide group means more than one £2m de minimis.
The result here is that if the parent entity has net tax interest expense and the non-consolidated subsidiary also has net tax interest expense, you don't collate these amounts as part of one CIR calculation. Instead, the parent entity will have its own CIR calculation based on its worldwide group position and the non-consolidated subsidiary, including any of its own subsidiaries, will become the ultimate parent of his own group and that group will be the scope of a second CIR calculation.
Care must be taken to not assume non-consolidated entities qualify for this exemption. A prudent position is to assume subsidiaries are consolidated until further investigation is undertaken to confirm that the ultimate parent is an investment entity under IFRS10.
What are Public Infrastructure Exemptions?
The Public Infrastructure Exemption (PIE) allows you to exclude third party debt interest from the CIR calculation. This can make a significant difference if the majority of interest expense is from third party bank debt or other unconnected debt.
Let’s look at an example for the ABC group (a UK group):
- third-party debt interest of £20m – this is the only interest expense
- tax-EBITDA of £50m
Under the fixed ratio the interest allowance is the lower of 30% tax-EBITDA or the fixed ratio debt cap as defined above, so in this example if would be 30% of £50m being £15m. This would give a restriction of £5m. A PIE election would exclude the third-party interest meaning that in this example, there would be no restriction.
This exemption is available for companies which provide public infrastructure assets, known as Qualifying Infrastructure Companies (QIC). These types of companies commonly have fairly steady cash flows and generate only a small profit margin over financing cost, so pose little risk in terms of the Base Erosion and Profit Shifting agenda which brought in the CIR rules.
There are detailed conditions which must be met, including an election which must be made for each company to qualify. The types of groups which tend to benefit are property investment groups and renewable energy groups, although the legislation gives detailed definitions of businesses which will qualify.
The challenge with the PIE election is that it assumes other figures are nil for the CIR calculation which can lead to a tax-EBITDA of nil. Additionally, for groups that include a QIC, in many cases the interest capacity will be calculated as if there were no £2m de minimis. Therefore, if there is related party debt interest, then the likelihood is that the majority, if not all, of the related party debt interest may end up being disallowed.
Let’s take our previous example, but assume the following:
- third-party debt interest of £10m
- related-party debt interest of £10m
- tax-EBITDA of £50m
With a PIE election there is likely to be a full restriction of the tax-EBITDA to nil and therefore the worst case is that the related-party debt interest is fully restricted. This results in a disallowance of £10m. If no election had been made, the disallowance would only have been £5m as per example 1.
It is important to look at the PIE election on a case-by-case basis to understand the debt makeup of the group. If it is mainly geared from investor debt or other related party debt then the chances are the PIE election is going to be less beneficial. However, if the majority of debt is third party debt interest, it could be worth making the election. The election must be made by the end of the accounting period, so work should be undertaken during the year to confirm either way.
The purpose of the CIR legislation is to restrict overly geared groups in the UK. The two planning points mentioned in this insight show how CIR needs to be considered proactively, and from a wider lens than just the headline of restricting net interest expense to 30% tax-EBITDA. Here at MHA we work closely with clients to ensure their CIR position is calculated and reported in the most tax efficient manner.
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