Corporate Interest Restriction and Reactivations of Disallowed Interest

Basic Rule

TIOPA 2010 section 373 (3).  The interest reactivation cap is: the the interest allowance of the group for the period less the net tax interest expense of the period. (If the result is negative the interest reactivation cap is 0).

373(6) A worldwide group is subject to interest reactivations if the interest reactivation cap is not nil and one member of the group is with the charge to corporation tax and has an amount available for reactivation in the return period.

Other rules

The amount available for reactivation by a company is defined in paragraph 26 of TIOPA 2010 schedule 7A.  Point to note the  is at a company level but generally the legislation works at a group level.

But full interest restriction returns must be submitted for the reactivation to take place.

To calculate the interest reactivation cap it is necessary to calculate the interest allowance for the period.  This is defined in TIOPA 2010 section 396 as the sum of the the basic interest allowance (i.e. the EBITDA multiplied by 30% or the group ratio bit) plus the net tax interest income of the group. 

Consultation on Capital Gains Tax on Non - Residents Investing in Commercial property

On the 22 November 2017 HMRC issued a consultation on: Taxing gains by non - residents on UK Commercial Property  This post:

• Summarises the contents of the HMRC consultation document.
• Identifies some possible consequences for life company investors.
• Looks at next steps.

The Consultation

Comes after a budget day 2017 announcement that tax will be charged on gains made by non  - residents on all types of UK immovable property.  There seems little prospect that this basic intention will be relaxed.  

The measure will expand the tax base both for capital gains tax and corporation tax. Corporation tax will apply to entities that would be within the charge to corporation tax were they UK resident. 

In addition to applying capital gains tax to direct disposals by non  - residents the rules will catch certain indirect disposals where a non - resident has a holding in a "property rich entity".  But those rules will only apply where the non resident had a holding of 25% or more in the property rich entity at the time of sale or in the 5 years prior to disposal.  There will be certain disclosure rules for advisers involved in a transaction to which the indirect disposal rules apply.

The new rules will extend to non  - resident holdings in residential property.  Such holdings are already subject to UK tax but using a confusing, piecemeal system. 

There will be a rebasing of property values to April 2019 so that only gains on UK commercial property accruing after that date are taxable.

At present some offshore collective funds are exempt from UK tax on UK property holdings by virtue of their non  - resident status.  It is proposed that such collectives will be liable to corporation tax  / capital gains after the introduction of the new rules.

Consequences For Life Companies

The area that is most important for life companies is the treatment of offshore collectives, currently not subject to capital gains tax.  Imposing a UK tax charge at the level of the offshore investment vehicle potentially makes such investments unattractive.  That is exempt pension policyholders will, indirectly, suffer the UK tax in the offshore fund which they should not be exposed to. [There is a similar issue for investors via SIPPs and ISAs].  Taxable policyholders are potentially exposed to double taxation of gains, once in the foreign collective and again in the UK life assurance company.

Next Steps

The consultation closed in February 2018 and HMRC are currently analysing feedback. There is a proposal to publish draft legislation in the late summer of 2018. Not surprisingly the proposals concerning offshore collective investment vehicles have been a cause of concern.  The response to the consultation by the Association of Real Estate Funds outlines some the difficulties and proposes certain solutions.  But until HMRC responds there is considerable uncertainty.  In the meantime it would seem unwise for a UK life insurance company to invest in or top up existing holdings in non  - UK resident property funds investing in UK aasets unless this is unavoidable.  For existing holdings it is probably necessary to wait and see what the draft legislation looks like before making decisions. 

Please see update for final rules.
(RB 8th April 2019)

Note on the corporate interest restriction

The legislation is in Part 10 TIOPA 2010 here and the legislation on interest returns in Schedule 7A.  Commencement and transitional provisions are in part 4 Finance (No2) Act 2017.  HMRC guidance (which is good) is here.

My idiots guide can be accessed google doc

Reading through the legislation there were three things that struck me as unusual.

1.  The aim of the legislation is to restrict tax deductible interest when the UK operations of a worldwide group have a higher level of gearing than the group as a whole.  But in calculating disallowed "interest" capital movements on loan relationships are taken into account as well as interest payable / receivable.

2.  The legislation does not include the customary ring fencing of life assurance policyholder and shareholder amounts.  A group including a life insurance company will have a single calculation which would include, for instance, capital movements on a portfolio of fixed interest bonds backing a pension annuity portfolio and interest paid on shareholder financing.

3.  The legislation works by calculating, on a group basis, an interest allowance which is 30% of tax EBITDA or, if an election is made, tax EBITDA multiplied by the group ratio.  (The group ratio is qualifying net (worldwide) interest expense / (worldwide) Group EBITDA).  For a company with BLAGAB business the tax EBITDA figure for that business is (presumably) I- E profit and not the commercial profit from the business.

All this means that the interest restriction rules would be messy for insurance companies and might give unforeseen results.  Due to regulatory constraints insurance companies are rarely big interest payers and the complexity is disproportionate to the risk of tax leakage.  But TIOPA 2010 section 456 provides welcome simplification.  (See page 67 of HMRC guidance, CFM 95640.)

This section allows companies (all companies not just insurance companies) who account for loan relationship assets on a fair value basis (i.e. mark to market) to substitute an amortised cost basis for the purposes of the corporate interest restriction.  The intention is to eliminate the  year on year fluctuations in "interest" caused by fair value accounting and capital movements being brought into account for the interest restriction.

However, it would be arduous for insurance companies to recalculate amounts brought into account on an amortised cost basis. Instead the 456 election includes a clause, 456 (6), specific to insurance companies, including Friendly Societies.  This provides that for insurance company assets accounted for on a fair value basis, only interest receivable is brought into the corporate interest calculation.  That is all capital movements on assets are excluded.  Most insurance companies have considerable policyholder investments in fixed interest bonds and the interest receivable included in the interest restriction calculation is likely to exceed any interest payable by the group in any accounting period.

Accordingly a group including an insurance company making the 456 election is unlikely to be caught by the interest restriction rules as it will always be in a net interest income position.  This is a welcome relief.

A 456 election is irrevocable and must be made within 12 months of the end of the relevant accounting period.

The relevant accounting period is the later of; The first accounting period where the corporate interest restriction legislation applies; and.

The first period in which the company uses fair value accounting for loan relationships. 

I tried to think of an instance where an insurance group or stand alone company would not want to make a 456 election but struggled to think of one.  Even a Friendly Society with no borrowing might want to make the election just to keep interest restriction calculations simple and remove the possibility that there could be an interest restriction in a "down" year.

One possible reason for not making the election might be to obtain better relief for losses.  I haven't considered the interest restriction and reactivation rules in chapter 2 of  part 10 TIOPA 2010 but they are very different from the rules for trading losses and management expenses.  It might be the case that in some circumstances a group would rather carry forward excess interest deductions than trading losses.  (I'm not saying this is the case just floating the possibility.) 

Another insurance company specific section is section 453 requiring, in certain circumstances,  a group including an insurance company to be split into two groups for the purposes of the corporate interest restriction calculation.

The legislation applies where an insurance entity has a subsidiary which it holds as a portfolio investment and requires the subsidiary (and any subsidiaries of the subsidiary) to be treated as a separate group for corporate interest restriction purposes.   

A portfolio investment is defined as one where

The insurance entity holds the interest as an investment, and

The insurance entity judges the value that the interest has to it wholly or mainly by reference to the market value of the investment.

I struggle to make sense of this wording.  HMRC's guidance (page 319) says it is intended to catch instances where the underlying business of the subsidiary is unrelated to insurance.  It's difficult to think of real world examples where this would be the case and the actual wording of the section does not require the subsidiary to be engaged in an activity unrelated to insurance.  This section might be a bit of a pain for groups with insurance entities which have subsidiaries and  face the possibility of HMRC suddenly deciding section 453 applies. 

Usual caveats apply, this note is for me, you are welcome to read it but it's not advice.