Changes to corporate interest tax relief

For many years, interest on debt has generally been deductible for corporation tax purposes (subject to certain anti-avoidance rules such as transfer pricing, thin capitalisation, and the worldwide debt cap). However, from 1 April 2017 the deductibility of interest will be restricted under rules introduced by the Finance (No.2) Act 2017.

The new restrictions apply to interest, amounts economically equivalent to interest, and the costs of raising finance.

While the rules are extremely complex this article provides a general summary of how they may affect insurers.

Summary of the new rules

Broadly, relief for a UK corporate group’s net interest expense is capped at 30% of its taxable earnings before interest, tax, depreciation and amortisation (EBITDA). These figures are taken from the UK corporation tax returns of each group company.

Where beneficial, an international group may alternatively elect to calculate the cap by reference to the ratio of the worldwide group’s net interest expense to its accounting EBITDA (the ‘group ratio’ cap). These figures are taken from the consolidated accounts for the worldwide group.

All UK groups will benefit from an annual £2 million minimum net interest allowance. This means that groups whose net interest expense is below £2million will be unaffected and where a group is affected, it will always be able to deduct at least £2million.

Where interest is restricted, the amount for which relief is not allowed will be carried forward and will be available for utilisation in future years, subject to the same ‘30%’ and ‘group ratio’ caps noted above. Furthermore, where a group does not incur sufficient interest to make use of the maximum amount of interest deductible in the period (calculated by applying the caps as above), this excess capacity can be carried forward for up to five years, increasing interest capacity for future accounting periods.

Interaction with existing restrictions

The rules relating to transfer pricing and thin capitalisation remain unchanged. However, the worldwide debt cap rules have been repealed and replaced by a ‘modified debt cap’ rule which broadly acts to ensure that a UK group’s net interest deduction, initially capped under either the ‘30%’ or ‘group ratio’ cap mechanisms outlined above, cannot exceed the net interest expense shown in the consolidated accounts for the worldwide group.

Insurance companies and groups

Previously, insurance companies and groups were exempt from the worldwide debt cap rules. They are now subject to the new corporate interest restriction rules, although most insurers are expected to be in a net interest income position.

Amortised cost basis election

Insurance companies typically hold interest generating investments to support their regulatory capital requirements. If these assets are accounted for at fair value, any unrealised gains or losses will be included in the calculation of net interest. Therefore, it was recognised that some insurers would experience significant volatility in their net interest result. The rules, therefore, give insurers the option to elect to apply an amortised cost accounting treatment for the purposes of calculating their net interest – thus removing the volatility. The election must be made within 12 months from the end of the accounting period and is irrevocable.

Portfolio investments held by insurance companies

An insurance company, in making investments to cover its insurance liabilities, may acquire an interest in a subsidiary whose underlying business is unrelated to the insurance business and the investments are essentially held for their income stream or resale value. This could allow the interest expense of the invested in subsidiary to be sheltered by the interest income position of the insurance group as a whole. To counteract this, the rules require the subsidiary to not be regarded as a consolidated subsidiary of any member of the worldwide group of the insurance company. Instead, the rules treat the subsidiary as part of a separate worldwide group.

What should insurance groups be doing?

Insurance companies and groups need to assess the impact of the new rules at an early stage and consider whether any action can be taken to mitigate any projected disallowances. We would be happy to assist with this exercise.

How Moore Stephens can help

Our dedicated Business Tax & VAT team of industry experts provide advice to underwriters, P&I clubs and other mutuals, outsourcers, Lloyd’s and multinational insurers and brokers. We advise clients on their statutory requirements and the most efficient ways of fulfilling these obligations, as well as preparing their corporate tax returns. We also advise many organisations on the most tax-efficient ways to structure their affairs and ensure that all available reliefs are utilised. With tax legislation being an area of regular change, our specialist team also helps clients stay abreast of the latest opportunities, as well as any potential pitfalls. We pride ourselves on the breadth and depth of our insurance expertise, offering specialist and tailored support to industry participants and regulators, locally and internationally.

For more information on the tax services we provide, or to discuss how the new rule changes will affect your business, please contact us.

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