CFM96460 - Interest restriction: group-EBITDA: capital (disposals) adjustment

TIOPA10/S419

In computing group-EBITDA, the capital (disposals) adjustment comes into play on the disposal of a relevant asset.

It is designed to ensure that when a relevant asset is disposed of, any loss on disposal recognised in the accounts is added to the profit before tax and interest in computing group-EBITDA, and any profit recognised in the accounts is subtracted. However, a further adjustment should be made to ensure that any gain relative to historic cost has been included in group-EBITDA on a cumulative basis.

The logic underlying this is that depreciation and amortisation, as components of EBITDA, include a net loss in the value of an asset, but should not include an overall gain. So, in computing group-EBITDA, only net expenses should be removed; any net gain should not be subtracted from profit. Such an adjustment is only triggered on disposal of a relevant asset. If a revaluation increases the carrying value of an asset to an amount exceeding historic cost, there is no corresponding restriction on the fair value gain that is subtracted in computing group-EBITDA.

The capital (disposals) adjustment

The capital (disposals) adjustment comprises three elements. It forms part of the overall depreciation and amortisation adjustment which is added to the profit before tax figure for the period in computing group-EBITDA.

The adjustment is calculated as A - B + C where

(A) is the amount of losses on disposal for relevant assets recognised in the group’s profit before tax (this is the loss relative to accounting carrying value at the beginning of the period of account or on acquisition if later).

(B) is, similarly, the amount of profits on disposal for relevant assets recognised in the group’s profit before tax.

(C) is the recalculated profit amounts.

The adjustment for item A adds losses on disposal to the group’s profit before tax in calculating group-EBITDA.

The adjustment for item B subtracts profits on disposal to the group’s profit before tax in calculating group-EBITDA.

The adjustment for item C, described as a ‘recalculated profit amount’ is designed to ensure that any cumulative net profit on an asset, as compared to historic cost, remains as a component of group-EBITDA.

It is possible that, as regards a particular relevant asset, the amount included in component C for a period exceeds the amount included in amount B. This will be the case where the relevant asset has already been revalued to an amount exceeding historic cost by the beginning of the group’s period of account.

These amounts only include items of a capital nature. Where the disposals are of a revenue nature then they do not form part of the capital (disposals) adjustment.

Recalculated profit amounts

Item C is the amount of profits on disposal of relevant assets calculated on the basis that any amounts written off or any revaluation adjustments are disregarded. As such, it calculates the profits on disposal on the assumption that the asset in question was not depreciated or amortised, and was not revalued or impaired. It therefore represents the gain on disposal, computed by reference to historic cost.

The profit on disposal is calculated as the excess of the relevant proceeds over the relevant cost. This should be the actual proceeds from the disposal less the actual cost of acquiring the asset.

Where the asset is sold at a loss compared with the cost of the asset, there is no adjustment to be made by item C. This is because the overall loss over the time that the group has held the relevant asset is similar in nature to amounts of depreciation and should correctly be added back to profits before tax in computing group-EBITDA. This treatment will normally align with the treatment of capital allowances, and the calculation of balancing allowances and balancing charges, which are all added back to the calculation of tax-EBITDA.

Group-EBITDA (Chargeable gains) election

The calculation of item C is performed differently where a group makes a chargeable gains election. This is to bring the calculation of C closer to the way the UK tax rules determine the amount of chargeable gains.

Practical issues

It may be that the group has disposed of a group of assets through the sale of a subsidiary rather than by way of an asset sale. However, an apportionment of proceeds may have taken place in drawing up financial statements. This should provide a starting point for calculating adjustments.

A pragmatic approach may be adopted. It is unusual that disposals of plant or machinery give rise to material gains, relative to historic cost. So, in computing item C, it should be possible to concentrate on those relevant assets that might be expected to have given rise to a gain by reference to historic cost.

What is not acceptable is to net off gains and losses, computed by reference to historic cost, because the losses cannot form part of item C. However, if a number of similar small items are disposed of together, it may be reasonable to take the view that any gains included in a net loss are unlikely to be material to the CIR calculations or that a reasonable estimate can be made on the basis of a sample test.

There may be cases where no apportionment of proceeds has taken place, and the sale of a consolidated subsidiary is simply treated as a disposal of a single discontinued operation for consideration equal to the price paid for the shares. One practical approach in calculating the capital disposals adjustment at S419 and the effect of any group-EBITDA (chargeable gains) election at S422 would be to determine these by reference to the underlying assets reflected in the consolidated balance sheet prior to sale.

The proceeds of disposal of the subsidiary should be allocated across the assets to calculate the amount to be included. The proceeds to be allocated should include the consideration received (for example, cash and the value of any other consideration received such as shares) plus the value of liabilities with the subsidiary immediately prior to the disposal that were assumed by the buyer. The proceeds may be allocated across the assets by any reasonable method of apportionment.

For guidance on relevant assets, refer to (CFM96470)