Consultation outcome

Tax deductibility of corporate interest expense: consultation (October 2015)

Updated 5 December 2016

This was published under the 2015 to 2016 Cameron Conservative government

1. Foreword

The government has continued with its strategy to deliver the most competitive corporate tax system in the G20, with the aim of encouraging greater investment to support productivity and growth, enabling UK based companies to compete successfully in global markets. The rate of corporation tax has been reduced from 28% in 2010 to 20% from April this year, and from 2017 it will be reduced further to 19% then to 18% in 2020. In parallel, we have increased the value of reliefs such as R&D tax credits that encourage business investment. But alongside this we are determined to tackle avoidance and aggressive tax planning, introducing new and effective legislative and administrative countermeasures. We now have a globally competitive tax system but we expect companies to pay the tax they owe, and to make a fair contribution to restoring stability to the public finances and reducing the deficit.

In recent years it has become clear that the international tax rules have not kept pace with globalisation and modern business practices which has led to some multinational enterprises exploiting the rules to pay little or no tax in many of the markets in which they operate. In 2013, the governments of the G20 and Organisation of Economic Co-operation and Development (OECD) launched the Base Erosion and Profit Shifting (BEPS) project to modernise and improve the international tax rules to drive out aggressive tax planning by multinational enterprises. Just two years later, the OECD has delivered reports on each element of the 15 point BEPS Action Plan, the outputs of which the Chancellor, and other G20 Finance Ministers, have now endorsed. The UK has already announced action on the 2014 outputs from the BEPS project to introduce country-by-country reporting and new rules to address hybrid mismatches.

At the summer Budget 2015 the government announced that it would be developing a new business tax roadmap for this Parliament. The government will as part of the development of that roadmap be considering the recommendations set out in the BEPS reports. One of the OECD recommendations concerns best practices on interest deductibility.

The use of interest expense has been identified as one of the key areas where there is a significant opportunity for BEPS by multinational companies. The OECD report under Action 4 of the BEPS project sets out recommendations for countering this. The government recognises this risk and so we are reviewing the rules on interest deductibility that apply within the UK in light of the recommendations set out in the OECD report. Consistent adoption and application of rules across all countries would have the benefit of certainty for business as well as ensuring a more level playing field.

The government believes that the new rules on interest deductibility as set out in the OECD report are an appropriate response to the BEPS issues identified therein. Due to the importance of this issue, we are publishing this document now to seek views from all stakeholders on how best to respond to the OECD proposals. We are interested in the views of all stakeholders on how to address BEPS issues involving interest expense in an effective and proportionate manner. The results from this consultation will be considered in the development of a future business tax roadmap.

David Gauke MP.

2. Introduction

Most OECD countries allow interest expense to be deducted in calculating taxable business profit while having rules to protect their tax base from excessive or tax-driven interest deductions. These rules may operate on either a general or transactional basis. Many countries, such as Australia, Germany, Italy, Japan, and Spain, already have rules that provide a structural restriction on tax relief for interest expense. Others, such as the US, have put forward proposals that would bring their current rules in line with the approach recommended in the OECD report. The UK’s worldwide debt cap is a general rule which provides a back stop for excessive interest deductions but its other rules are essentially transactional. Under its transfer pricing rules the UK restricts tax relief for interest to the arm’s length amount but this restriction takes no account of whether the income and assets supporting that interest are taxable. Despite a number of targeted rules to supplement the arm’s length test, significant planning opportunities can arise from both external and intra-group interest expenses.

Both inbound and outbound groups can use debt flows to shift profits around, which potentially create competitive distortions between groups operating internationally and those operating in the domestic market. As identified in the BEPS Action Plan (OECD, 2013), when groups exploit these opportunities, it reduces the revenues available to governments and affects the integrity of the tax system.

To address these risks, the OECD report on Action 4 of the Base Erosion and Profit Shifting project (OECD publication 2015) sets out recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense. Through the development of the OECD report on best practices on interest deducibility, countries have agreed a general tax policy direction and it is expected that there will be convergence over time through the implementation of agreed common approaches.

To meet the OECD recommendations, the UK would need to introduce a new general rule for restricting interest. The government recognises that this would be a major change to the UK corporate tax regime and will require careful consideration to ensure any new rules work appropriately, including taking into account the beneficial impact of an 18% corporation tax rate.

3. Scope of consultation

The government wishes to look at ways to tackle BEPS involving interest expense in order to reduce unfair outcomes and imbalances in the tax system. However, the government wants to ensure the UK tax system remains competitive so that it continues to play a part in attracting and retaining business investment in the UK.

The government wants to ensure that there is certainty for businesses operating in the UK, and that they can continue to obtain deductions for interest expenses commensurate with their activities, while limiting risk to the exchequer. Any changes to tackling BEPS involving interest expense would also need to be operationally efficient and take account of the compliance and administration burden for the government and business.

This document summarises the key aspects of the OECD report on Action 4 and sets out some specific questions to frame a discussion for a UK domestic policy context. At this stage, the government is seeking views from all stakeholders on the proposals in the OECD report. The responses to this document will be considered in the development of a future business tax roadmap.

3.1 How to respond

Please send response by email to BEPSinterestconsultation@hmtreasury.gsi.gov.uk.

3.2 Deadline for responses

14 January 2016.

4. The OECD best practice recommendations on interest expense

In 2013, the governments of the G20 and Organisation of Economic Co-operation and Development (OECD) launched the Base Erosion and Profit Shifting (BEPS) project to modernise the international tax rules to prevent aggressive tax planning by multinational enterprises. The BEPS Action Plan was published by the OECD in July 2013 and contains 15 Actions. Action 4 of the Action Plan on Base Erosion and Profit Shifting called for the:

[development of] recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments. The work will evaluate the effectiveness of different types of limitations.

Working Party No. 11 of the Committee on Fiscal Affairs (CFA), part of the OECD, examined the existing approaches taken by countries to prevent base erosion and profit shifting using interest. In December 2014 the OECD published a discussion document and invited comments from interested parties.

The OECD has now published its report on Action 4 of the Base Erosion and Profit Shifting project (OECD publication 2015), setting out its recommendations for a best practice approach to the design of rules to prevent base erosion through the use of interest expense.

The report identifies three basic scenarios in which BEPS involving interest and payments economically equivalent to interest can arise:

• groups placing higher levels of third party debt in high tax countries
• groups using intragroup loans to generate interest deductions greatly in excess of the group’s actual third party interest expense
• groups using third party or intragroup financing to fund the generation of tax exempt income

The recommended approach to address these risks has at its core a rule which limits net deductions for interest to a percentage of a company’s earnings before interest, taxes, depreciation and amortisation (EBITDA). To be effective, this fixed ratio rule would also apply to payments economically equivalent to interest. To ensure that countries apply a fixed ratio that is low enough to tackle BEPS, while recognising that not all countries are in the same position in terms of the size and make-up of their economies, the recommended approach includes a corridor of possible ratios of between 10% and 30%. The report also identifies some of the factors which countries should take into account in setting their fixed ratio within this corridor.

The report states that countries introducing a fixed ratio rule may choose to include an alternative restriction which would allow a deduction for net interest expense determined by the level of the net interest/EBITDA ratio of its worldwide group. Where the interest deduction permitted under this group ratio rule exceeded the deduction permitted by the fixed ratio rule, then the higher limit would generally apply.

A group ratio rule based on earnings may be replaced by other group ratio rules, such as the ‘equity escape’ rule (which compares tax-adjusted measures of an entity’s level of equity and assets to those of its group) currently in place in some countries. Countries may also choose not to introduce any group ratio rule.

The recommended approach also allows countries to supplement the fixed ratio rule with other provisions that reduce the impact of the rules on either entities or circumstances which pose less BEPS risk, such as:

• a de minimis threshold which carves-out companies which have a low level of net interest expense. Where a group has more than one entity in a country, the OECD recommends that the threshold be applied to the total net interest expense of the local group
• an exclusion for interest paid to third party lenders on loans used to fund public-benefit projects, subject to conditions. This exclusion is intended to recognise that an entity may be highly leveraged but, due to the nature of the projects and the close link to the public sector, the BEPS risk is reduced
• the carry forward of disallowed interest expense and/or unused interest capacity (which arises where a company’s actual net interest deductions are below the fixed ratio) for use in future years. This would reduce the impact of earnings volatility on the ability of an entity to deduct interest expense. The carry forward of disallowed interest expense would also help companies which incur interest expenses on long-term investments that are expected to generate taxable income only in later years, and would allow companies with losses to claim interest deductions when they return to profit.

The report also recommends that the approach be supported by targeted rules to prevent its circumvention, for example by artificially reducing the level of net interest expense. It also recommends that countries consider introducing rules to tackle specific BEPS risks not addressed by the recommended approach, such as where an entity without net interest expense shelters interest income.

Finally, the report recognises that the banking and insurance sectors have specific features which must be taken into account and therefore there is a need to develop suitable and specific rules that address BEPS risks in these sectors.

The OECD will conduct further technical work on specific areas of the recommended approach, including the detailed operation of the worldwide group ratio rule and the specific rules to address risks posed by banking and insurance groups. This work is expected to be completed in 2016.  

5. Summary of the OECD’s best practice recommendations on interest expense

De minimis monetary threshold to remove low risk entities

Optional

+

Fixed ratio rule

Allows an entity to deduct net interest expense up to a net interest/EBITDA ratio within a corridor of 10%-30%

+

Group ratio rule

Allows an entity to deduct net interest expense up to its group’s net interest/EBITDA ratio, where this is higher than the fixed ratio

Option for a country to apply a different group ratio rule or no group ratio rule

+

Rules to address volatility

Including carry forward of disallowed interest / unused interest capacity and/or carry back of disallowed interest

Optional

+

Public-benefit project exclusion

Optional

+

Targeted rules to support general interest limitation rules and address specific risks

+

Specific rules to address issues raised by the banking and insurance sectors

6. UK implementation of the OECD best practice recommendations on interest expense

6.1 Timing

A key question for consideration is when it would be appropriate to introduce new rules in the UK. Many countries already have rules that provide a structural restriction on tax relief for interest expense. Consideration will need to be given to if and when other countries act upon the recommendations in the OECD report. Some businesses are already starting to respond to the outputs of the BEPS project in general.

A balance will need to be struck between protecting the UK tax base and allowing businesses sufficient time to adapt to the new rules. If new rules are introduced in the UK it is unlikely this would be before 1 April 2017.

Question 1: What are your views on when a general interest restriction should be introduced in the UK?

6.2 Scope of an interest restriction

Companies in large multinational groups pose the main base erosion and profit shifting risk. However, depending on their design, rules which only applied to multinational groups could discriminate in favour of domestic groups and stand-alone companies. This could harm the UK economy and may be contrary to EU law.

The OECD report includes the option for countries to consider introducing a group ratio rule in combination with the fixed ratio rule (see section 6.6 below). Depending on the design of such a rule, it could ensure that no restriction arises for domestic groups and stand-alone companies in respect of interest paid to third parties.

Question 2: Should an interest restriction only apply to multinational groups or should it also be applied to domestic groups and stand-alone companies?

6.3 Definition of interest

The OECD report recommends that the restriction should cover interest on all forms of debt, payments economically equivalent to interest and expenses incurred in connection with the raising of finance. The report recommends that they should include, but not be restricted to, the following:

• payments under profit participating loans
• imputed interest on instruments such as convertible bonds and zero coupon bonds
• amounts under alternative financing arrangements, such as Islamic finance
• the finance cost element of finance lease payments
• capitalised interest included in the balance sheet value of a related asset, or the amortisation of capitalised interest
• amounts measured by reference to a funding return under transfer pricing rules, where applicable
• notional interest amounts under derivative instruments or hedging arrangements related to a company’s borrowings
• certain foreign exchange gains and losses on borrowings and instruments connected with the raising of finance
• guarantee fees with respect to financing arrangements
• arrangement fees and similar costs related to the borrowing of funds

It is recognised that foreign exchange gains and losses on instruments to hedge or take on a currency exposure connected with the raising of finance are not generally economically equivalent to interest. The report notes, however, that countries may wish to treat some or all foreign exchange gains and losses on these instruments as economically equivalent to interest, in line with local tax rules.

The report recommends that the restriction does not apply to payments which are not interest, economically equivalent to interest or incurred in connection with the raising of finance. Therefore in general, the rules would not limit deductions for items such as:

• foreign exchange gains and losses on monetary items which are not connected with the raising of finance
• amounts under derivative instruments or hedging arrangements which are not related to borrowings, for example commodity derivatives
• discounts on provisions not related to borrowings
• operating lease payments
• royalties
• accrued interest with respect to a defined benefit pension plan

Question 3: Are there any others amounts which should be included or excluded in the definition of interest?

Question 4: How could the rules identify the foreign exchange gains and losses to be included?

6.4 Fixed ratio rule

The key proposal in the OECD report is for a general rule that would restrict the amount of relief a group can claim for its net interest expense to a fixed percentage of the group’s taxable earnings before interest, depreciation and amortisation (“tax EBITDA”) in that country. In the UK, depreciation would refer to capital allowances.

The OECD report envisages a restriction applying either at a company or local group level. Ensuring the rule is effective at the level of the local group would require a mechanism to balance disallowances in one group company with additional capacity to deduct interest in another, which might be more complex than applying the rules to the aggregate position of all UK companies the same group (the “UK sub-group”).

Rules operating on a UK sub-group basis would nevertheless need to allocate any restriction to individual companies. This allocation may affect the amount of tax payable (for example, due to interaction with loss relief) and who pays it (in view of minority interests). It may also interact with rules to address volatility, such as those contemplated in section 6.8 below.

Assuming the rule is to be applied at the UK sub-group level, the computational steps for the fixed ratio rule could be as follows:

(1) Calculate the sum of the tax EBITDAs of all companies (and UK Permanent establishments) in the UK sub-group.

(2) Multiply this sum by the fixed ratio percentage.

(3) The resulting figure gives a cap for allowable net interest expense for the UK sub-group.

(4) For the UK sub-group as a whole, any net interest expense in excess of the cap would be non-deductible (but the rules could provide for this amount to be carried forward and be relieved in future periods – see section on addressing volatility below).

(5) The rules could either determine mechanically how the non-deductible amount is to be allocated to individual companies or allow taxpayers an element of choice.

The table below illustrates a simple example of a fixed ratio rule based on EBITDA using fixed ratios of 30%, 20% and 10% and the resulting amount of interest relief being denied in the local group in each case:

Fixed ratio (% of EBITDA)	30%	20%	10%
Taxable EBITDA (£m)	600	600	600
Net interest expense (£m)	200	200	200
Net allowable interest (£m)	180	120	60
Interest restricted (£m)	20	80	140

The fixed ratio rule would apply to all interest, whether paid to related or unrelated parties.

Question 5: If the rules operate at the UK sub-group level, how should any restriction be allocated to individual companies?

Question 6:Are there items which should be excluded from both the definition of interest and from “tax EBITDA”, as referred to in the section on a fixed ratio rule?

6.5 Setting a fixed ratio

The operation of the fixed ratio rule requires the fixed ratio to be set at a level which is appropriate to tackle base erosion and profit shifting. The OECD report recommends that countries should set the fixed ratio percentage in a corridor of 10% to 30%.

If a fixed ratio rule was implemented in the UK, the level of the fixed ratio would need to balance tackling BEPS effectively against allowing UK companies to deduct interest arising on third party debt that is used to finance assets and activities that are taxable in the UK. Where this balance would be struck may depend on which of the optional aspects of the OECD recommendations were implemented in the UK.

The OECD report identifies some factors that could be taken into account when setting a fixed ratio in the range of 10% to 30%, including:

• whether the fixed ratio rule operates in isolation or in combination with a group ratio rule
• whether there is carry forward of unused interest capacity or carry back of disallowed interest expense
• whether there are other targeted rules that specifically address the base erosion and profit shifting risks involving interest expense
• the interest rate environment
• constitutional or other legal reasons (e.g. EU law requirements) that require the same treatment to different types of companies which are viewed as legally comparable, even if these entities pose different levels of risk
• the size of the group

Should the OECD recommendations be adopted in the UK, the government would assess how to apply these and other factors in setting a benchmark ratio in the UK. The OECD report acknowledges that different countries will place different weightings to be placed on each factor.

Question 7: What do you consider would be an appropriate percentage for a fixed ratio rule within the proposed corridor of 10% to 30% bearing in mind the recommended linkages to some of the optional rules described below?

6.6 Group ratio rule

The OECD report includes an optional group ratio rule for countries to consider introducing in combination with the fixed ratio rule. The group ratio rule would replace the fixed ratio rule for determining the interest restriction with a ratio based on the position of the worldwide group. The group ratio rule would permit some groups that have a higher level of external gearing to deduct interest in excess of the amount allowed under the fixed ratio.

The ‘group ratio’ could be calculated as the ratio of net third-party interest expense to EBITDA in the GAAP accounts for the worldwide group as a whole. This could be aligned with the fixed ratio rule, using the same calculation of entity EBITDA based on tax numbers, and the same carry forward or carry back provisions.

A number of countries currently apply a fixed ratio rule in combination with a group ratio rule using an assets-based ratio. For example, Germany has an ‘equity escape’ rule whereby the fixed ratio rule based on net interest/EBITDA does not apply if a company can show that its tax-adjusted equity/total assets ratio is equal to or exceeds that of its group (within a small tolerance). Under the OECD’s recommendations, a country may also apply a group ratio rule based on asset values.

The OECD report notes that there will be cases where countries decide to apply a fixed ratio rule in isolation. As noted above, this could be one factor to consider when setting the fixed ratio within the OECD’s recommended corridor of 10% to 30%.

The inclusion of a group ratio rule may allow the interest restriction regime to be better targeted at BEPS (which is more likely to arise where the interest expense in the UK exceeds the group ratio). It would also allow groups which for commercial reasons are more highly leveraged, to obtain a higher amount of interest relief. However, by permitting more highly-leveraged groups to benefit from greater interest deductions, this increases the incentive to obtain funding through debt rather than equity. This may exacerbate the debt/equity asymmetry and encourage over-indebtedness amongst groups, thereby increasing the level of financial risk to which they are exposed.

A group ratio rule would inevitably introduce additional complexity to the legislation and to the tax computations of groups taking advantage of it. It requires rules to identify the worldwide group, to define interest and EBITDA on an accounting basis, including the exclusion of related party interest, and make certain adjustments to relate the accounting ratio to the rules based on tax EBITDA. Additional rules may be needed to deal with interest and earnings associated with joint ventures and other investments that are not consolidated on a line-by-line basis.

The OECD will lead further work on recommendations for the design and operation of group ratio rules to be completed in 2016.

Question 8: What are your views on including in any new rules an option for businesses to use a group ratio rule in addition to a fixed ratio rule?

6.7 De minimis threshold

The OECD report says a de minimis threshold can be applied to ensure that the rules are targeted where the greatest BEPS risk lies and to reduce compliance costs on business. Arguably the simplest way of applying the threshold would be to permit any group to deduct its net UK interest expense up to a fixed amount regardless of the calculated interest cap. It is estimated that setting such a de minimis at £1 million would exclude over 90% of companies in the UK. A group with a net UK interest expense below £1 million would be entitled to deduct all its interest expense. A group with a net UK interest expense above £1 million would be entitled to a net deduction for interest equal to the higher of £1 million and the cap calculated according to the interest restriction rules. The operation of the rule is illustrated in the table below using a threshold of £1 million.

(£000’s)	Group A	Group B	Group C
Net interest expense	800	1,200	1,200
Calculated cap on net interest	calculation unnecessary	900	1,100
Interest deduction (net)	800	1,000	1,100

In addition, as the OECD report suggests that the greatest BEPS risk lies with large MNEs, groups which are classified as micro, small or medium-sized according to EU criteria (“SMEs”) could be exempted from the rules .

Question 9: What form of de minimis threshold would be most effective at minimising the compliance burden without introducing discrimination or undermining the effectiveness of any rules?

Question 10: What level should the de minimis threshold be set at, balancing fairness, BEPS risks and compliance burdens?

Question 11: Should SMEs as defined by the EU criteria be exempted from the rules, in addition or as an alternative to a de minimis threshold?

6.8 Addressing volatility

The OECD report includes a number of options for countries to deal with volatility in earnings, including averaging and the use of carry forward and carry back of disallowed interest and carry forward of unused interest capacity. The need for including these options depends to some extent on the percentage for the fixed ratio rule. Allowing carry forward of disallowed interest expense would seem to be the simplest approach to addressing volatility and is consistent with the operation of the UK tax system. There is a risk that the carry forward of unused interest capacity or the carry back of disallowed interest would otherwise permit excess capacity to build up in the economy over time, which might lead to tax-driven business combinations in order to utilise that capacity. Some countries with existing restrictions permit carry forward of both disallowed interest and unused capacity, in some cases with time limits, particularly in respect of unused capacity. Concerns may also arise when a company changes ownership or changes the nature of its economic activity. Some countries with existing restrictions place further conditions on the use of carry forwards in these circumstances, as does the UK in connection with other reliefs.

Question 12: What is the best way of ensuring that the rules remain effective and proportionate even when earnings are volatile?

6.9 Public-Benefit Project (PBP) Exclusion

The OECD’s report recognises that there are some large scale, highly geared projects which are privately owned but result in provision of a public benefit. The OECD also acknowledges that due to the close relationship with the public sector, these projects present little or no risk of base erosion and profit shifting.

As a result, the OECD’s best practice approach includes an option for countries to exclude from the general rule the interest expense incurred on third-party loans linked specifically to projects which deliver a public benefit.

The OECD explains that the exclusion should be narrowly targeted, and that the circumstances in which the exclusion could apply should be limited to cases where:

• an entity (the operator) establishes a project to provide (or upgrade), operate and/or maintain assets on a long-term basis, lasting not less than 10 years, and these assets cannot be disposed of at the discretion of the operator
• a public sector body or a public benefit entity (the grantor), contractually or otherwise obliges the operator to provide goods or services in which there is a general public interest . This provision must be subject to specific controls or a regulatory framework in addition to rules applying generally to companies or other commercial entities within a jurisdiction
• interest is payable by the operator on a loan or loans obtained from and owed to third party lenders on non-recourse terms, so that the lender only has recourse to and a charge over the assets and income streams of the specific project. Arrangements involving recourse to other assets, guarantees from other group companies or which otherwise seek to offer recourse beyond the project assets would not qualify for the exclusion.
• the loan or loans made to the operator do not exceed the value or estimated value of the assets at acquisition or once constructed, unless additional investment is made to maintain or increase their value. Subject to minimal and incidental lending to a third party (such as a bank deposit), none of the funds should be on-lent.
• the operator, the interest expense, the project assets and income arising from the project are all in the same country, where the income must be subject to tax at ordinary rates (i.e. those applied to other taxpayers not providing goods or services in which there is a general public interest). Where the project assets are held in a permanent establishment, the exclusion will only apply to the extent that income arising from the project is subject to tax at ordinary rates in the country applying the exclusion. *similar projects of the operator or similar projects of other entities of the operator´s group are not substantially less leveraged with third-party-debt, taking into account project maturities.

The OECD report additionally offers countries the option make further impositions in order to prevent abuse of the exemption, such as a main purpose test.

Where a PBP exclusion is claimed, income and interest expense attributable to the project would be omitted from fixed or group ratio rule calculations for the entity or group. Each use of the exclusion would be disclosed to other tax authorities with a legitimate interest (i.e. where foreseeably relevant) under tax information exchange agreements, whose interest restriction rules may also take account of the PBP exclusion claimed. If a group ratio rule is implemented, many of the public-private partnership projects which could benefit from the PBP exclusion may not need to use it. In the cases where the project vehicle is not consolidated into any other group it would be treated as a group for the purpose of the group ratio rule, permitting a deduction for the whole of its third party interest expense, subject to other tax rules.

Question 13: In what situations would businesses choose to use the PBP exclusion? How would this differ if no group ratio rule was implemented?

Question 14: Do you have any suggestions regarding the design of a PBP exclusion, taking account of the OECD recommendations?

6.10 Targeted rules

The OECD report also says that countries should consider using targeted rules to prevent manipulation of the general rules and to address specific BEPS risks not covered by the general rules. Suitable targeted rules may enable the fixed ratio to be set at a higher level, subject to the overall 30% limit in the OECD recommendations.

Question 15: Do you have any views on the specific risks that might sensibly be dealt with through targeted rules?

6.11 Banking and insurance groups

The OECD report recognises that the recommended best practice approach is unlikely to address BEPS in the banking and insurance sectors for a number of reasons. In particular, banking and insurance groups are important sources of debt funding for groups in other sectors and as such many are net lenders by a significant margin. This means that the main operating companies in these groups, and the groups overall, will often have net interest income rather than net interest expense. The fact that interest income is a major part of a bank or insurance company’s income means that EBITDA would not be a suitable measure for economic activity across a group in these sectors.

The OECD report also suggests that the restrictions imposed by regulatory requirements lowers the BEPS risk in banking and insurance groups. However, not all companies within banking and insurance groups are regulated at the solus level, and there can be BEPS risks from borrowing involving non-regulated entities. The OECD will undertake further work on this area in 2016.

The UK recognises that it may not be appropriate to apply the general rules as proposed by the OECD to banking and insurance groups. The UK intends to work with the OECD and business to develop rules that could be introduced alongside the general rules or to modify the general rules to address the specific BEPS risk posed by the banking and insurance groups.

Question 16: Do you have any suggestions as to how to address BEPS issues involving interest raised by the banking and insurance sectors?

6.12 Transitional rules

The OECD report says that a country may also apply transitional rules which exclude interest on certain existing loans from the scope of the rules, either for a fixed period or indefinitely. The OECD report recommends that these transitional rules are primarily restricted to interest on third party loans entered into before the rules were announced, and that interest on any loans entered into after the announcement of the new rules should not benefit from any transitional provisions.

Providing relief from the rules for existing loans would discriminate in favour of existing loans and may distort funding arrangements for business. However, it is acknowledged that there may be particular cases where transitional rules may be needed to prevent unfair outcomes or unintended consequences. Taking into account the other design options set out in the OECD best practice framework, the government would expect grandfathering of existing loans to be available only in exceptional circumstances.

Question 17:What are the types of arrangement for which transitional rules would be particularly necessary to prevent any rules having unfair or unintended consequences, and what scope would these rules need to be effective?

6.13 Interaction with other restrictions on tax relief for interest

The UK already has a number of rules limiting tax relief for interest under certain circumstances, including the Worldwide Debt Cap (WWDC), transfer pricing rules and certain anti-avoidance rules. It is envisaged that any new interest restriction would operate after the transfer pricing rules and anti-avoidance rules, including the anti-hybrid rules to be introduced following the OECD report on Action 2. Any rules which became redundant as a result of new rules could be repealed. It is envisaged that any new interest restriction would replace the WWDC, or the WWDC would need to be adapted to fit with the new approach.

Question 18: To what extent do you believe that the new general interest restriction rule should replace existing rules?

7. Summary of questions

1. What are your views on when a general interest restriction should be introduced in the UK?
2. Should an interest restriction only apply to multinational groups or should it also be applied to domestic groups and stand-alone companies?
3. Are there any others amounts which should be included or excluded in the definition of interest?
4. How could the rules identify the foreign exchange gains and losses to be included?
5. If the rules operate at the UK sub-group level, how should any restriction be allocated to individual companies?
6. Are there items which should be excluded from both the definition of interest and from “tax EBITDA”, as referred to in the section on a fixed ratio rule?
7. What do you consider would be an appropriate percentage for a fixed ratio rule within the proposed corridor of 10% to 30% bearing in mind the recommended linkages to some of the optional rules described below?
8. What are your views on including in any new rules an option for businesses to use a group ratio rule in addition to a fixed ratio rule?
9. What form of de minimis threshold would be most effective at minimising the compliance burden without introducing discrimination or undermining the effectiveness of any rules?
10. What level should the de minimis threshold be set at, balancing fairness, BEPS risks and compliance burdens?
11. Should SMEs as defined by the EU criteria be exempted from the rules, in addition or as an alternative to a de minimis threshold?
12. What is the best way of ensuring that the rules remain effective and proportionate even when earnings are volatile?
13. In what situations would businesses choose to use the PBP exclusion? How would this differ if no group ratio rule was implemented?
14. Do you have any suggestions regarding the design of a PBP exclusion, taking account of the OECD recommendations?
15. Do you have any views on the specific risks that might sensibly be dealt with through targeted rules?
16. Do you have any suggestions as to how to address BEPS issues involving interest raised by the banking and insurance sectors?
17. What are the types of arrangement for which transitional rules would be particularly necessary to prevent any rules having unfair or unintended consequences, and what scope would these rules need to be effective?
18. To what extent do you believe that the new general interest restriction rule should replace existing rules?