The UK’s Corporate Interest Restriction (“CIR”) may not be relevant to a UK company or UK group if the net UK interest expense of the company or group is less than £2m. However, that doesn’t necessarily mean the rules should be ignored or forgotten.
There may be times when the UK interest expense of a UK company or group increases to above £2m and therefore, as a result, the CIR rules should be considered. This might happen in a number of circumstances such as:
- A UK company takes on additional debt to fund an acquisition;
- A UK company takes on additional debt to increase trading capacity/increase production;
- A private equity firm or an investor uses loan notes to invest in the UK company; or
- A company is now able to claim an interest deduction for certain amounts of interest that had accrued over the years. For example, cash paid interest under the UK’s late paid interest rules
In these circumstances, the risk is that the sudden increase in interest expense would result in a restriction under the CIR rules.
Reminder of the CIR rules
The CIR rules are very complicated and the summary and commentary set out below is a simplification for the purpose of the article.
As a reminder, the UK CIR rules came into force on 1 April 2017 and seek to restrict the UK corporation tax deductions on interest expenses in excess of £2m in certain circumstances.
Where a group’s UK interest expense is more than £2m in a period, the amount of interest that can be deducted for corporation tax purposes is restricted to the “interest allowance” for the period – which can be calculated in two separate ways; either using the fixed ratio method or group ratio method.
- Fixed ratio method – the default mechanism for calculating the interest allowance. This compares two amounts and the lower of the two determines how much interest is deductible:
- 30% multiplied by the tax-EBITDA (broadly the UK EBITDA measured using tax principles); and
- The fixed ratio debt cap (broadly the interest expense as shown in the consolidated financial statements of the group).
- Group ratio method – Similar to the fixed ratio method, it uses the lower of two amounts to determine how much interest is deductible:
- Group ratio percentage (calculated as a worldwide group’s net interest expense (which excludes related party debt) as a proportion of the worldwide group’s tax-EBITDA); and
- The group ratio debt cap (which is broadly similar to the fixed ratio debt cap with some adjustments which may make this smaller than the fixed ratio debt cap, but not larger).
Companies are able to adopt the method that gives a greater interest allowance. If the UK net interest expense exceeds the interest allowance calculated, then interest is restricted. This restricted interest can then be carried forward to a future accounting period and reactivated if there is sufficient interest allowance in that period.
To the extent any interest allowance is not used in a period because the UK net interest expense is less than the calculated interest allowance, the interest allowance can be carried forward for up to five years to use in future accounting periods provided certain administrative procedures are followed.
What to consider?
In certain circumstances, it may be beneficial to utilise unused interest allowance from earlier periods. However, based on our experience, companies are not always fully aware of what administration is required in order to utilise the unused interest allowance from prior periods.
Broadly, unused interest allowance can only be carried forward where a full interest restriction return (“IRR”) has been submitted in the period in which the allowance was generated. However, if UK interest expense has been less than £2m for several years, a company or a group may not file a full IRR because the CIR rules do not apply. Having to do so would increase costs and administration.
Where CIR does not apply, we would generally recommend that the company or group submit an abbreviated IRR instead. This is much simpler, and less information is required. Prior to submitting an abbreviated IRR, a company must be nominated as the reporting company for the group so it is important that this is also done.
By submitting an abbreviated IRR, a company or group protects themself as this allows a full IRR to be submitted in a later period – even where the usual dates for amendment have passed. This layer of protection means that if a company suddenly has an increased interest expense in the UK for CIR purposes and some of that would be restricted because of the interest allowance calculation under the fixed ratio or group ratio method, it can look back five years to determine if there was any unused interest allowance which can now be utilised.
Taking this approach means the administrative burden is reduced when CIR does not apply but by submitting the abbreviated IRR the company has protected itself to ensure it can access the unused interest allowance if it is ever needed in the future, potentially ensuring there are no sudden restrictions on interest deductions which could increase amounts of cash tax payable.
Key takeaways
If a company or group considers there to be a risk of interest expenses exceeding £2m in a future accounting period, it is recommended that an abbreviated IRR is filed within 12 months of the end of the accounting period (even if there is no restriction under the CIR rules). This offers a layer of protection against a restriction, or reduces a restriction, under the CIR rules in a future period.
We hope that you find this briefing note helpful. However, please note that it has been prepared for awareness purposes only and, as such, represents only a high-level and simplified summary of the CIR rules. It does not constitute tax advice and is not a substitute for taking proper advice tailored to your specific circumstances. We would recommend that tax advice is sought if any of the above could be applicable.
