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HMRC internal manual

Guidance on Real Estate Investment Trusts

HM Revenue & Customs
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Group conditions and rules: interest cover test: consequences of breaching the limit

Section 115 FA 2006 sets a limit of 1.25 on the ratio of rental profits (before capital allowances) to interest. Definitions of the terms in the formula can be found at GREIT12050.


Group G is a Group REIT. Based on the amounts shown in the financial statements for G (tax-exempt) (see GREIT12160), the aggregate tax-exempt business income of members of the group are 95, after deduction of 5 capital allowances. For the accounting period, the financing costs of all the tax-exempt business of each member of the group (FCA) are 90. The external financing costs (FCE) in respect of the group’s tax-exempt property rental business was 95 (as worked out from the financial statement for G (property rental business) - see GREIT12155).

The ‘profits’ of G (tax-exempt) (are as measured by section 120 FA 2006) are 95 - 90 = 5. The top line of the fraction would be 100 = 5 + 5 + 90, and the ratio would be 100/95 = 1.05, which breaches the 1.25 limit (a breach is when the fraction is b e l o w 1.25).

To work out the income that is chargeable on the residual part of the principal company of the group, the first step is to work out the amount of interest that would just meet the 1.25 limit. A bit of algebra tells us that if 1.25 = (P+FCA)/FCL then FCL = 4(P + FCA)/5, where P is profits before capital allowances and FCL is the external financing cost that just meets the limit. Therefore the external financing cost that just meets the limit in this example is 80.

The other chargeable income of the residual part of the principal company of group G would therefore be 10 (= 90 - 80).