CFM97630 - Interest restriction: charities: companies with exempt property income

This guidance applies for accounting periods beginning before 1 April 2023. For accounting periods beginning on or after 1 April 2023, TIOPA10/S382(1A) applies to exclude finance costs incurred by charities from the scope of tax-interest expense amounts.

This guidance is relevant to companies that receive property income to which a charitable exemption applies and to worldwide groups containing such companies.

It is also relevant to entities such as housing associations that may take a variety of legal forms, including industrial co-operatives, provident societies, companies or trusts. Except in the case of trusts, they will normally be within the ambit of corporation tax. See CTM40400+

Where such income would otherwise be taken into account as property income, the analysis of the application of the CIR is different from that where a company has charitable trade profits CFM97620.

The difference arises because the loan relationship and derivative contracts debits and credits are not taken into account in determining the amount of property income that would otherwise be taxed. Such debits and credits are taken into account in computing the company’s non-trading loan relationships deficit (NTLRD). Even if, as a practical matter, it is unlikely that those NTLRDs can be used, it is not possible to conclude that such amounts are not taken into account for corporation tax purposes. Therefore those debits and credits can be tax-interest expense or tax-interest income amounts.

Note, however, that where interest income falls within the income that is exempted by CTA10/S468, such interest income will not be tax-interest income amounts.

Generally, amounts that are exempted from being brought into account for corporation tax purposes are not included in the calculations of tax-interest or tax-EBITDA for CIR purposes.

Calculation of tax-EBITDA in respect of exempt property income

CTA10/S485 provides an exemption from tax on property income where such income is applied for charitable purposes only. Such income may be income that would normally be taken into account under CTA09/PT4 property income.

As a result, such amounts will not be included in calculating the company’s tax-EBITDA. In the absence of any other non-exempt income, the company’s tax-EBITDA would be zero.

Calculation of tax-interest in respect of exempt property income

Although the property income of the charity will be excluded from being brought into account, funding costs are likely to give rise to a NTLRD, so it is not possible to come to the conclusion that the interest costs of the housing association cannot be deducted.

The exclusion at CTA10/S485 only applies to income that would fall to be brought into account under CTA09/PART4. Where a charitable company has financing costs from loan relationships and derivative contracts taken out for the purposes of the property business, these can still give rise to a NTLRD. Such a NTLRD could be used and could be a tax-interest expense amount (TIOPA10/S373(4)(a)).

As already mentioned, in practice, it is unlikely a charity can use its NTLRD because this might require a loss of charitable status, but since it is conceivable that a NTLRD could be relieved, the amounts are not rendered incapable of being tax-interest expense amounts by TIOPA10/S373(4)(a).

The rules restricting the use of NTLRDs by charitable companies are found at CTA09/S456(1)(b)(ii) (which prevents CTA09/PT5/CH16A from applying, in place of CH16) and CTA09/S459(3).

Practical issues

Where a company with exempted property income is subject to CIR, for instance, if it has net tax-interest expense exceeding the de minimis amount (CFM95220), this may simply reduce the charitable company’s NTLRD, for which it would be unlikely, in practice, to obtain relief anyway.

Accordingly, the company or its worldwide group might decide to take action to meet the administrative requirements of the CIR (TIOPA10/SCH7A) despite the lack of practical effect.

Example: Stand-alone company

For definitions of technical terms used in this example, see the glossary at CFM99500. For a summary of the core rules see CFM95200+.

In the 12-month period of account to 31 March 2018, a stand-alone housing association has property income of £4.50m (before funding costs). The tax-adjusted property trading profits (before funding costs) is £4.35m. The interest expense on borrowings (all from unrelated parties) is £3.13m and credits on interest rate derivatives are £0.08m (measured on an accruals basis).

The property trading profits of £4.35m are exempted by CTA10/S478. Accordingly tax-EBITDA is nil. However, as the accounting measure of the property profits is £4.50m, the contribution to group-EBITDA would be £4.50m.

It has a NTLRD of £3.05m (£3.13m less £0.08m). The housing association single member worldwide group’s aggregate net tax-interest expense (ANTIE) is £3.05m.

Its adjusted net group-interest expense (ANGIE) is also £3.05m and as the interest expense is all related party, its qualifying net group-interest expense (QNGIE) is also £3.05m.

Applying the fixed ratio method, the single-member worldwide group’s basic interest allowance is 30% of its tax-EBITDA, which is zero. The fixed ratio debt cap is higher at £3.05m, so does not affect the calculation. Accordingly, the interest capacity of the single member group is governed by the de minimis amount, which is £2m per annum.

An interest restriction arises, equal to the ANTIE minus interest capacity of £1.05m (£3.05m - £2m). This reduces the NTLRD to the de minimis amount, £2m.

The group ratio here would be more than 30%; it is QNGIE/group-EBITDA, £3.05m/£4.50m = 67.8%. But as tax-EBITDA is zero, the basic interest allowance is still zero and so the interest restriction is again £1.05m.

As a general point, for such a single member group with a charitable property business, the NLTRD will be capped at a maximum of the de minimis amount, being £2m per annum. However, the disallowance is unlikely to have a practical effect because relief for any NTLRD would be unlikely.

Since the NTLRD cannot exceed the de minimis account, it should not be necessary to perform a detailed calculation.

Stand-alone company - possible approach to compliance

Where a stand-alone company benefits from exemption on rental income under CTA10/S485, it might choose not to appoint itself as the reporting company of a single-member worldwide group but rather simply file its company tax return on the prudent basis that the CIR reduces its NTLRD to £2m (per annum) – the de minimis interest capacity under TIOPA10/S392(3).

Alternatively, it could appoint itself as a reporting company and file a full interest restriction return for each period of account. Many of the figures to be included in the return would be obvious - for instance, tax-EBITDA of zero, and interest capacity equal to the de minimis amount.

If the ANTIE exceeds the de minimis amount, it and the disallowance could be approximate figures, so long as the difference between the two equals the de minimis amount. But, if this approach is adopted, it should be stated that the return contains estimates. In these circumstances it is acceptable to include a note in the interest restriction return to the effect that it is not expected that the estimates will be replaced by more refined figures in a future revised return. In this particular circumstance, in the absence of other reasons, the levying of a penalty under TIOPA10/SCH7A/PARA27(5) would not be appropriate.

If the company has appointed itself as reporting company for the first period to which the CIR applies, it can change its approach for a later period of account and thereafter by revoking the appointment within the time limit applicable to that period. It would, however, still need to file an interest restriction return for any periods before that in which the revocation takes effect.

Some charitable companies may not be required to submit a company tax return every year. Where this approach has been agreed with HMRC, the charitable company need not submit a company tax return simply to demonstrate how it has dealt with the CIR. It may proceed on the conservative basis that its NTLRD is zero.

Groups including a charitable company with exempt property profits - reporting company appointed

Where the charitable company is part of a wider group and there are NTLRDs arising in the company, a group may appoint a reporting company, which allows additional flexibility, for instance, in allocating disallowances.

If a group does appoint a reporting company, it will need to submit either an abbreviated interest restriction return (if it is clear that no interest restriction can arise) or a full return (if there is a restriction). It may be possible to use some appropriate and prudent estimated amounts, for instance, the tax-interest expense of charitable property companies may be estimated, if it is to be disallowed in full.

Where an interest restriction arises, the CIR rules do not prevent the allocation of an interest restriction to a charitable company with NTLRDs, before allocating residual restriction (if any) to other group companies so long as it is a consenting company. The restriction would then be applied to the NTLRD, which would not otherwise be used.

In this context, note the requirement in TIOPA10/SCH7A/PARA27(3) to notify HMRC if an interest restriction return still contains estimates 36 months after the end of the worldwide group period of account to which it relates. In these circumstances, it is acceptable to include a note in the interest restriction return to the effect that it is not expected that the estimates will be replace by final figures in a future revised interest restriction return. In this particular circumstance, in the absence of other reasons, the levying of a penalty under TIOPA10/SCH7A/PARA27(5) would be inappropriate.

Groups including a charitable company with exempt property profits - circumstances where a reporting company may not be required

So long as the net tax-interest expense of the non-charitable companies in the group, taken together, does not exceed the de minimis amount of £2m per annum, HMRC will accept a filing approach that does not involve the appointment of a reporting company. Instead, each charitable company files its company tax return on the conservative basis that its NTLRD is zero. The non-charitable companies file company tax returns with no interest restriction.

The rationale for this approach is that, no matter how low the group’s tax-EBITDA, it will always have an interest allowance of at least the de minimis amount. Therefore in a full year, there must be tax-interest expense of at least £2m that is not disallowed and where the non-charitable companies have less than this amount of net tax-interest expense, it would always have been possible to allocate all of the disallowance against tax-interest expense of the non-charitable companies.

Normally, to enable a non-pro rata allocation of all of the disallowance to reduce, in priority, non-trading loan relationships deficits of charitable property companies in the group, the group would need to appoint a reporting company and file an interest restriction return. But under this limited circumstance, it would not be appropriate for HMRC to appoint a reporting company if the group did not appoint one.

This approach would not be acceptable if NTLRDs of a charitable company is surrendered as group relief or otherwise used. In those circumstances, the group would need to either appoint a reporting company and submit a full interest restriction return, or if no reporting company is put in place, allocate disallowances on a pro rata basis.

Group-EBITDA and group-interest

CFM97640 provides details of how the CIR rules work in the context of a group that includes a charitable company.