I have always enjoyed the role of an educator, combining a tax and business advisory career with book-writing, conference speaking and university teaching, all for the past 44 years. Not only did I learn in the process; I hope I have been giving back to the world, educating young (and not so young) minds and especially showing the importance of thinking ahead of changes in the tax avoidance legislation worldwide.
OECD’s Base Erosion and Profit Shifting (BEPS) project addresses all the cross-border planning techniques that have brought the profession of a tax advisor into disrepute. It has created a 21st century playing field and we must all know the new rules.
Over the next 6 months, Dmitry and I intend to write one article a month on the way the various Action points under the BEPS initiative of the OECD are being actioned and implemented (or disregarded) by various countries. This month’s newsletter is about interest, the tax-deductible sort (or perhaps non-deductible sort). Next month will be Treaty Access and limitations; the following month will be prospective changes to taxation in the digital economy; the following one may be International Tax Disputes and how Action 14 may be implemented.
We will be discussing the above and other BEPS Action points at the IBSA conference coming up in a couple of weeks (click here). I do hope to see many IFS Newsletter readers at this event at the Landmark hotel, London, on 18th November, so do please contact me if you would like to attend.
I always like hearing from colleagues and clients, new and old, and in the meantime, I hope you enjoy reading the current update in interest deductibility.
With kind regards
Debt v Equity and Notional Interest Deduction
In our October 2015 newsletter, we discussed the Base Erosion and Profit Shifting (BEPS) project for which the OECD had just finalised their Action Points recommendations. Unlike EU’s legislation that has immediate effect when it becomes national law (which is obligatory for all EU Member States), or some federal legislation that is immediately transposed in the Member States’ jurisprudence, recommendations given by the BEPS Action Points are … only recommendations. However, in seeking to prevent multi-national corporations (MNCs) shifting profits from high tax to low tax jurisdictions and achieving unintended tax benefits, we have seen many countries enthusiastically implementing the BEPS proposals, including some non-OECD members.
Most Action points bring a sea-change to how MNCs operate with some points being more obvious than others; however, Action 4 is amongst the easiest to comprehend. It limits the amount of interest that a company or a group can deduct in calculating its taxable profit by introducing a cap of between 10% and 30% of EBITDA on both internal and external debt. This is different from previous debt:equity ratios which looked at the capital ratios of the two methods of financing, since it now relates interest deductibility to profits of the organisation. Moreover, the limits that have been imposed on internal debt for many years as a development of thin capitalisation rules, have not included external debt in the equation. This has far reaching issues. For example, the external recipient will always be taxed on the interest receivable, but the payor may have a limited deduction, resulting in a tax mismatch. And companies within an international group may require finance in particular sectors where EBITDA profitability is limited, or even non-existent, even though the overall group finance is within the prescribed limits. This has in fact been recognised by the OECD and resulted in amended recommendations for banks and insurance groups.
For many years the UK’s legislation has provided for a host of measures in an attempt to achieve an effect similar to that of Action 4, such as thin capitalisation rules and debt cap as mentioned above. However, the Budget 2016 has introduced new restrictions on interest deductibility, including an interest deduction cap of 30% of EBITDA, with a de-minimis group amount of £2 million in interest payments per annum, below which the cap would not apply. The updated draft legislation is expected in early December 2016 and will come into effect on 1 April 2017.
Our colleagues and landlord, Simmons Gainsford, in their analysis of the original proposals of how they apply to UK property exploitation, concluded that the new rules only applied to UK corporation tax payers and not to income tax payers such as non-resident landlords. That conclusion has clearly also been noted by other respondents to the consultation document and has been picked by the UK Government. In their follow-up consultation document, the UK Government is now proposing to widen the interest cap to non-resident landlords to create a “level playing field” with UK corporate landlords!
The effect of this legislative change can be summarised as follows:
- Where a property portfolio held by an offshore investor / fund has an EBITDA of circa £10 million which would otherwise be sheltered by (say) £9 million of interest costs resulting in taxable profits of £1 million and tax of £200,000 pa.
- The interest cap would restrict interest costs to £3 million leaving £7 million of income subject to income tax at 20% = £1.4 million pa i.e. an increase in tax of £1.2 million pa which could have a very dramatic impact on cash flows and yield.