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HMRC internal manual

Corporate Finance Manual

Interest restriction: core rules: the group ratio method

TIOPA10/S398

The second method for computing the basic interest allowance of the worldwide group for a period of account is the group ratio method. This method is applied where the reporting company makes a group ratio election (TIOPA10/SCH7A/PARA13). This election may be revoked.

Applying this method, the basic interest allowance is the lower of:

  • the group ratio percentage of the aggregate tax‑EBITDA; and
  • the group ratio debt cap for the period.

Group ratio percentage

The group ratio percentage is computed by dividing the group’s qualifying net group-interest expense (QNGIE) for a period of account by its group-EBITDA for the period. The group ratio percentage is capped at 100% and is also set to 100% if this calculation gives a negative result or if group-EBITDA is zero (s399).

Qualifying net group-interest expense (QNGIE)

The same measure of net external interest expense, QNGIE, is used as the denominator in calculating the group ratio percentage and as the basis for the group ratio debt cap.

QNGIE is based on the ANGIE, but excludes some expense amounts that are taken into account in computing the ANGIE. These include amounts arising on financial liabilities owed to related parties, amounts arising on results dependent securities, and amounts arising on perpetual and very long-dated instruments.

Group-EBITDA

Group-EBITDA is based on an accounting measure of the group’s profit before tax, increased by its net group-interest expense with adjustments for depreciation and amortisation. In these calculations, a loss is treated as negative profit, and income as negative expense.

Elections may be made to use alternative methods for the calculations, which may then better align tax and accounting measures.

The group ratio debt cap

The group ratio debt cap works in a similar way to the fixed ratio debt cap. It is the sum of QNGIE and any excess debt cap brought forward from the previous period. The same amount of excess debt cap brought forward is used for the group ratio debt cap as for the fixed ratio debt cap.

The group ratio debt cap can be smaller, but never larger than the fixed ratio debt cap as some expense amounts included in the ANGIE are excluded from QNGIE.

Simple examples

If no amounts are brought forward from earlier periods, and the de minimis amount is not relevant, under the group ratio method the interest restriction becomes:

  • The aggregate net tax-interest expense for the worldwide group

less the lower of:

  • the group ratio percentage of the worldwide group’s aggregate tax-EBITDA; and
  • the group ratio debt cap for the period of account.

Example C

Aggregate net tax interest expense   (A) 50
       
Aggregate tax-EBITDA   (B) 100
### Fixed ratio method      
30% of aggregate tax-EBITDA (30% of B) (C) 30
Fixed ratio debt cap = ANGIE   (D) 90
Basic interest allowance (lower of C or D) (E) 30
Fixed ratio method restriction (A - E) (F) 20
### Group ratio method      
Group-EBITDA   (G) 200
Group ratio debt cap = QNGIE   (H) 90
Group ratio percentage (H/G) (I) 45%
Group ratio percentage of aggregate tax-EBITDA (I x B) (J) 45
Basic interest allowance (lower of H or J) (K) 45
Group ratio method restriction (A - K)   5

 

In Example C, electing for the group ratio method reduces the disallowance significantly.

Example D

Aggregate net tax interest expense   (A) 50
       
Aggregate tax-EBITDA   (B) 100
### Fixed ratio method      
30% of aggregate tax-EBITDA (30% of B) (C) 30
Fixed ratio debt cap = ANGIE   (D) 90
Basic interest allowance (lower of C or D) (E) 30
Fixed ratio method restriction (A - E) (F) 20
### Group ratio method      
Group-EBITDA   (G) 200
Group ratio debt cap = QNGIE   (H) 56
Group ratio percentage (H/G) (I) 28%
Group ratio percentage of aggregate tax-EBITDA (I x B) (J) 28
Basic interest allowance (lower of H or J) (K) 28
Group ratio method restriction (A - K)   22

 

Example D differs from Example C in that QNGIE is much lower than ANGIE, perhaps because much of the group’s external interest expense is payable to related parties. As a result the group ratio method is not beneficial.

Example E

Aggregate net tax interest expense   (A) 90
       
Aggregate tax-EBITDA   (B) 100
### Fixed ratio method      
30% of aggregate tax-EBITDA (30% of B) (C) 30
Fixed ratio debt cap = ANGIE   (D) 90
Basic interest allowance (lower of C or D) (E) 30
Fixed ratio method restriction (A - E) (F) 60
### Group ratio method      
Group-EBITDA   (G) 90
Group ratio debt cap = QNGIE   (H) 81
Group ratio percentage (H/G) (I) 90%
Group ratio percentage of aggregate tax-EBITDA (I x B) (J) 90
Basic interest allowance (lower of H or J) (K) 81
Group ratio method restriction (A - K)   9

 

Example E shows deductions for tax-interest limited to QNGIE, the group ratio debt cap. The application of the group ratio method still significantly reduces the disallowance as compared to the fixed ratio method.

Example F

Aggregate net tax interest expense   (A) 120
       
Aggregate tax-EBITDA   (B) 100
### Fixed ratio method      
30% of aggregate tax-EBITDA (30% of B) (C) 30
Fixed ratio debt cap = ANGIE   (D) 120
Basic interest allowance (lower of C or D) (E) 30
Fixed ratio method restriction (A - E) (F) 90
### Group ratio method      
Group-EBITDA   (G) 60
Group ratio debt cap = QNGIE   (H) 120
Group ratio percentage (H/G, capped) (I) 100%
Group ratio percentage of aggregate tax-EBITDA (I x B) (J) 100
Basic interest allowance (lower of H or J) (K) 100
Group ratio method restriction (A - K)   20

 

In example F, all the group’s external interest expense of 120 is borne by UK companies. There are operating losses outside the UK. Consequently, group-EBITDA, a worldwide measure, is substantially lower than tax-EBITDA, a UK measure. Further, the group is in a global net loss position, as its interest expense exceeds group EBITDA. In this example, the group ratio percentage is capped at 100% by s399. This means that the net deduction for tax-interest cannot exceed tax-EBITDA. Even so, the application of the group ratio method significantly reduces the disallowance as compared to the fixed ratio method.