A detailed summary of the debt cap rules
- The principle of the debt cap measure is to limit relief for deductions in respect of excessive debt owed by the UK members of a group. The measure applies whether the UK group companies are members of a UK or non-UK headed group. The amount of excessive debt is established by comparing the costs of borrowing (referred to as finance expenses), rather than snapshots of debt. The comparison is made between the net borrowing costs of the UK members of the group and the gross borrowing costs of the group as a whole.
- A group is defined by reference to international accounting standards (IAS) - companies whose results would be included in the consolidated accounts of a group are members of the group for the debt cap. The general definition of a group by reference to IAS, is supplemented by additional rules that ensure there can only be one ultimate parent for a group and explain the circumstances under which certain entities cannot be treated as an ultimate parent. The UK members of the group, whose net borrowing costs form the UK measure, must be 75% subsidiaries of the ultimate parent of the group - they are referred to as ‘relevant group companies’.
- Finance expenses for both the UK and worldwide measures are interest and interest-like costs, such as a discount. They include the finance charge element of finance leases and debt factoring charges. They do not include borrowing costs such as foreign exchange adjustments or hedging. In the main, however, finance expenses will be interest costs.
- The accounting period of the group forms the backbone of the comparison. Both the UK measure and the group (or worldwide) measure are calculated by reference to a period of account of the group.
- The worldwide measure (the ‘available amount’) is taken from the figures that make up the consolidated accounts of the worldwide group. In other words, the figure is an accounts based figure.
- The UK measure (the ‘tested expense amount’) is tax based, and is derived from figures that would otherwise be brought into account as deductions for corporation tax purposes. It includes both intra-group and external finance expenses payable by the UK group companies. The tested expense amount is the aggregate of each relevant group company that has a net financing deduction. If relevant group company A has finance expenses of 100 and finance income of 40, it has a net financing deduction of 60. If relevant group company A has a net financing deduction of 40, relevant group company B has a net financing deduction of 60, and relevant group company C has net finance income of 50, the tested expense amount is 100; the net finance income of C is not taken into account.
- Where the amount of net finance expense for any relevant group company is less than £500,000, then that company is ignored; the net finance expense is not included in the calculation of the tested expense amount. HMT have the power to amend the figure of £500,000 by way of an affirmative regulation making power.
- Where the tested expense amount is greater than the available amount, the excess is disallowed (this is referred to as the “total disallowed amount”). The group provides a statement 12 months after the end of the period of account that sets out how the disallowance will be allocated among the UK members of the group - the group decides how the disallowance is to be allocated among the companies.
- Where there is a disallowance for a period of account, the group can reduce the financing income received by UK group companies so that this financing income is not taxable. The amount of financing income that can be disregarded is set by the aggregate of UK group companies that have net financing income (this amount is referred to as the ‘tested income amount’), but the amount of financing income that can be disregarded cannot be bigger than the total amount disallowed. A UK member of the group does not have to be a relevant group company to contribute towards the tested income amount. A group company that is a member of the group for IAS purposes and that is resident in the UK, or is a UK permanent establishment can be included. These companies are referred to as ‘UK group companies’. The group provides a statement 12 months after the end of the period of account that sets out how the amount of finance income to be reduced is to be allocated among the UK members of the group - the group decides which companies can reduce their finance income.
- The statements of disallowance and disregard can be varied at any time within a period of three years from the end of the relevant period of account of the group. The statements can be made by a UK member of the group that has been nominated by the rest of the UK members of the group.
- In order to help ensure the debt cap rules are compliant with relevant EU law, there is an additional set of rules within the debt cap measure dealing with finance income received by a UK group company from another group company that is resident within the EEA (apart from the UK). Where the EEA payer does not receive a tax deduction for the finance income it pays to the UK, then the finance income is exempt from corporation tax.
- The debt cap measure only applies to a group where the UK members of that group are ‘large’; small and medium companies are excluded. The definition of a SME is based on the test applied by the EU and is the same test used by the UK transfer rules.
- There is a gateway test that applies a quick, accounts based test to each large group. The amount of net debt owed by each relevant group company is added together to produce a total figure of UK net debt. A relevant group company that has net cash assets is ignored. If the total of UK net debt is less than 75% of the worldwide group’s consolidated gross external debt, then the gateway is failed and the rest of the debt cap measure does not apply for that accounting period of the group. Both the gross worldwide debt figure and the UK net debt figures are the average of the opening and closing figures on the balance sheet for the period of account of the group and relevant group companies.
- Particular business activities require the use of borrowed money in order for that business to operate. The rules provide exclusions for financial services groups who generate substantially all of their income from lending activity, insurance business or dealing in financial instruments. There are two alternate tests - the first test is by reference to the group as a whole, the second test is by reference to just the aggregate income of the UK members of the group.
- The debt cap rules do not apply to companies within
- The North Sea ring fence
- The tonnage tax regime
- The REIT regime.
16. There is an elective exclusion for UK group companies where substantially all their income is derived from group treasury activities such as cash pooling, receiving deposits, making loans and investing excess cash. The exclusion covers standalone treasury companies and treasury companies that have more complex arrangements where the treasury activity is effectively spread over two or more companies. 17. There is an elective regime to exclude an amount of finance expense from the calculation of any particular UK group company’s net finance expense where the finance expense arises in respect of short-term debt. Short-term debt is an intra-group loan relationship of less than 12 months. Regulations prevent groups masking long-term debt by arranging loans so that they appear as a series of short term loans. 18. As a result of making a disallowance of finance expense and then a corresponding disregard of finance income, a group may find that profits are switched from one UK group company to another UK group company. While there may be no overall additional corporation tax for the group to pay (as the amount disallowed is matched with an amount disregarded), the group may find that because profits have shifted from one company to another, they can no longer make use of pools of non-trading loan relationship deficits brought forward from previous years. Similar problems can arise in respect of management expenses being set against finance income that has to be disregarded. In both cases there is an elective regime that allows particular amounts of finance expense to be ignored in applying the debt cap measure. This ensures that the group can still access the pool of non-trading loan relationship deficits and management expenses. 19. An amount of finance expense falls outside the rules where the recipient of the interest or other payment is a charity. This most frequently happens where a charity lends money to a trading subsidiary. Without this rule the debt cap measure might result in a disallowance of finance expense allocated to the trading subsidiary, with a corresponding reduction in the finance income received by the charity. As finance income received by a charity is exempt from corporation tax, the shift in tax burden results in an unintended tax increase for such groups. 20. There are similar exemptions for finance arrangements between a trading subsidiary and one of the following
- Educational establishments as defined by SI1992/42
- Local Authorities as defined by CTA10/s1130
- Health Service Bodies as defined by CTA10/s985.
21. The composition of a group is decided by reference to which group entities would be included in the consolidated financial statements of the ultimate parent, if the accounts were prepared in accordance with International Accounting Standards. Additional rules explain when accounts drawn up using other GAAP will be acceptable for the purposes of the debt cap measure. Special rules are provided to deal with groups headed by dual listed companies and groups where companies’ and entities’ shares are stapled. The ultimate parent must be a body corporate except where the ultimate entity has interests that are traded on a recognised stock exchange. 22. The debt cap rules apply to a group for its first period of account that begins on or after the 1 January 2010. There are anti-forestalling rules to prevent groups shortening their pre-debt cap accounting period and so putting off application of the rules by up to 12 months. 23. Where any party enters into a scheme in order to frustrate the intention of the debt cap rules, anti-avoidance rules negate the impact of the scheme. The anti-avoidance rules contain filters including a main purpose test and excluded schemes. For the main set of debt cap rules, schemes that don’t actually reduce the overall CT profits of the UK members of the group (or increase CT losses) are not subject to the anti-avoidance rules.