An extra £10bn capital allowances will need to be identified each year to mitigate the restrictions on tax relief for bank interest and carried forwards tax losses. Few companies, particularly in the property sector are aware of this fundamental change to UK taxation.
In the current season of Panamania with the attention on tax havens, avoidance and politicians personal tax arrangements, it has obscured two fundamental tax changes that will be introduced in April 2017. These are the restrictions on interest relief and carried forwards tax losses.
Restrictions on tax relief for bank interest
Currently companies can offset all interest expenses incurred on borrowings against taxable profits subject to some restrictions for transfer pricing and loan relationships.
Announced on 16 March in the Budget 2016 a restriction will be introduced from 1 April 2017 for interest deductions as a result of OECD recommendations based on the Base Erosion and Profit Sharing (BEPS) project. The new legislation will bite where companies deduct more than £2m of interest. Assuming all in interest costs of 5% this could apply to companies with total debt of above circa £40m.
Instead of being able to deduct from taxable income all of the bank interest. It will be limited to 30% of earnings. A Fixed Ratio Rule is introduced which limits the interest deduction to 30% of taxable earnings in the UK being earnings before interest, taxes depreciation and amortisation (EBITDA); or based on the net interest to earnings ratio for the worldwide group.
There is an exclusion for those companies with a de minimis level of interest expense and this has been set at £2m. Large public infrastructure projects have also been excluded from the new rules.
Debt funding is integral to the real estate sector and the full detail of these rules will need to be established. As leverage levels in real estate business are generally much higher than other industries interest as a proportion of other expenses is more material to the business.
The Treasury in their budget policy costings estimate that this change will result in additional taxation being paid of circa £1bn each year.
The UK commercial property sector has not really realised the impact for their businesses where taxable profits exceed £5m. The British Property Federation has estimated that the tax cost is £660m/year purely for the property sector.
The British Property Federation (BPF) is concerned about the impact of these changes and responded to the consultation, “restricting the deductibility of debt will damage investment in real estate,” and “increase its overall cost to real estate borrowers.”
Lovell Consulting advise that one of the easiest ways to mitigate this change is to make sure that historic and current capital allowances have been claimed. Some companies have simply sheltered taxable profits through interest deductions and not bothered fully identifying allowances. Going forwards for larger companies’ failure to claim allowances this will be costly in tax terms.
Restrictions on tax relief for brought forwards losses
As part of a double whammy The Treasury will restrict brought forward losses to 50% of profits above £5m. The Treasury estimate this will result in extra tax being collected of circa £0.4bn with a further £0.5bn for specific restrictions targeted on the banking sector.
Together these two tax changes will collect extra tax of circa £2bn. Based on a current 20% corporation tax rate this would mean an extra £10bn of capital allowances would need to be identified each year to mitigate these changes.
The new rules from 2017 will make capital allowances even more valuable to businesses. Although the Government indicated they were aimed a very large companies in the property sector debt of 40m is a modest number. Assuming a loan to value across a portfolio of just 50% this indicates any property business with assets above £80m may be affected.
It is therefore an excellent time to revisit capital allowances planning.