CFM96770 - Interest restriction: joint ventures: interest allowance (non-consolidated investment) election: overview

Where a worldwide group has an investment in a non-consolidated entity any interest expense will not ordinarily be included in the net group-interest expense (NGIE) for the group. In addition, the group-EBITDA will include the group’s share of the entity’s profits for the period and, as a result, this can deflate the group ratio for the investing group.

Where debt is held in the non-consolidated entity then the investing group has an option to make an interest allowance (non-consolidated investment) election. The effect of making this election is at TIOPA10/S427. This gives the investing group a share of the non-consolidated entity’s adjusted net group-interest expense (ANGIE) and qualifying net group-interest expense (QNGIE). The group will also have a share of the group-EBITDA of the entity.

To take this option, the reporting company must make the election in the interest restriction return. This should specify which non-consolidated investments the election should apply to.

The interest allowance (non-consolidated investment) election only affects the ANGIE, QNGIE and the group-EBITDA of the worldwide group that has the investment in the non-consolidated entity. The non-consolidated entity itself is not effected by the election. The election does not affect the tax-interest amounts or tax-EBITDA of the worldwide group.

Definitions

Principal worldwide group

The ‘principal worldwide group’ as defined in TIOPA10/S427(2)(a). This is the worldwide group which is making the interest allowance (non-consolidated investment) election - the investing group.

Associated worldwide group

‘The associated worldwide group’ is defined in TIOPA10/S428. This is a worldwide group of which a specified ‘non-consolidated associate’ is the ultimate parent of the associated worldwide group.

TIOPA10/S428(3)(a) relaxes the normal rule so that the specified non-consolidated associate can be a partnership and still be the ultimate parent of the associated worldwide group.

Non-consolidated associate

A ‘non-consolidated associate’ is defined in TIOPA10/S429. This is an entity which, in respect of the principal worldwide group, satisfies one of the following conditions:

  • Condition A covers entities that are joint ventures or associates and use the gross equity or equity method of accounting.
  • Condition B covers partnerships that have been consolidated into the accounts and have elected into an interest allowance (consolidated partnerships) election.
  • Condition C covers a non-consolidated subsidiary of the principal worldwide group, for example, subsidiaries that are held at fair value.
  • Condition D covers partnerships and other transparent entities where the interest in the entity is accounted for on a fair value basis.

This means where a group with an investment in an entity meets one of these conditions, the worldwide group can elect to make the interest allowance (non-consolidated investment) election in respect of that entity.

‘Entity’ and ‘transparent entity’ are defined at S429(6). Transparent entities include unit trusts, whether or not a transparency election has been made under TCGA92/SCH5AAA/PARA8.

How to apply the election

  • Amounts from loans made by the principal worldwide group to the associated worldwide group are disregarded (S427(3)(a)/S428(5)).

Such loans are ignored for the purposes of calculating ANGIE and QNGIE. But if the loan is made between related parties, the interest expense on this loan should already be excluded from QNGIE for the borrower.

For example, principal worldwide group X makes a loan to associated group Y and results in Y making an interest payment to X of 50. X and Y are related parties. This loan transaction will not affect the QNGIE of Y. However, with the election, Y’s ANGIE should be reduced by 50 for the purpose of applying S429(4) for X’s calculation of QNGIE. This does not affect Y’s QNGIE in its own calculation. X’s income receipt of 50 will be ignored, meaning that the ANGIE and QNGIE in X will be increased by 50.

  • Amounts of group-EBITDA of the principal worldwide group that relate to its share of profits and losses of the associated worldwide group are disregarded (S427(3)(b)).

For example, principal worldwide group X holds a 50% share of the profits in associated group Y. If Y has profits before tax of 100 then X is entitled to 50% of these profits, so its group-EBITDA should include 50. If an election in relation to Y is made, then group-EBITDA of X should be reduced by 50.

  • Amounts of ANGIE, QNGIE and group-EBITDA in the principal worldwide group are increased by the appropriate proportion of the associated worldwide group (S427(4)-(6)).

In the computation of ANGIE or QNGIE, this increase is given effect as an additional element in the computation required by S413(1) or S414(1), respectively. It follows that in either case, if the end result of this process is a negative number, S413(2) or S414(2) treats ANGIE or QNGIE as nil.

The appropriate proportion is defined as the proportion of profits or losses the principal worldwide group is entitled to.

For example, principal worldwide group X has a 50% holding and 50% entitlement to the profits of associated worldwide group Y. Y has profit before tax of 150 after deducting third party interest expense of 50. Y has ANGIE and QNGIE of 50. Y has no depreciation or amortisation and so has group-EBITDA of 200 (profit before tax of 150 + interest expense of 50 added back).

Absent the election, accounting profits of 75 (50% of 150) in respect of Y should be included in group-EBITDA of X. Absent the election, no amounts of group-interest should be included in respect of Y.

With the election in place in respect of its investment in Y, X should remove the 75 from group-EBITDA. Instead, X should be able to increase its ANGIE and QNGIE by 25 (50% of 50). Group X should increase its group-EBITDA by 100 (50% of 200).

Therefore, the net effect of the election on group-EBITDA for X should be to increase it by 25.

Non-consolidated associate joining the group during period of account

There may be circumstances where the non-consolidated associate becomes a member of the principal worldwide group part way through a period of account.

For example, the principal worldwide group may obtain further share capital of an associate for it to become a subsidiary of the group. If this happened after six months after the beginning of a 12-month period of account and the adjustments for the election applies on a just and reasonable basis for the first 6 months of the period of account, no adjustments should arise in the final 6 months of the period of account.

Principal worldwide groups acquiring or disposing of some shares of the associated worldwide group in a period of account

The principal worldwide group may hold different amounts of shares in the associated worldwide group throughout a period of account. When determining the appropriate proportion for the purposes of S427(4) to (6), this can be determined by a method that is just and reasonable. A weighted average of the amount of proportion of the profits determined by the numbers of days this situation existed could be appropriate.

For example, the principal worldwide group held a 20% proportion of the associated worldwide group for 100 days and increased its proportion to 40% for 265 days in the period of account. Assuming that the profits and or losses received from the associated group were in line with this shareholding, the appropriate proportion could be calculated to be:

100/365 × 20% + 265/365 × 40% = 34.5%

Examples

The next four examples show how this election works for different circumstances.

  • Example 1: Opaque joint venture (JV) entity
  • Example 2: Opaque JV entity with loan from the Principal Worldwide Group
  • Example 3: JV Group
  • Example 4: Transparent JV