CFM97740 - Interest restriction: property and REITs: disallowance allocated to residual business exceeding its net tax-interest expense

TIOPA10/S452(6) to (10) and (4A)

S452(6) to (10) set out rules governing the allocation of a CIR disallowance to an actual company between the deemed PRB company and the deemed residual business company. (See CFM97720).

The allocation of a CIR disallowance to the actual company must not exceed the net tax-interest expense of the actual company, referred to as the 'total REIT expenses' in step 1 of S452(6). This is consistent with the general rules on allocation of CIR disallowances. It is also not possible for a CIR disallowance to be allocated to the deemed PRB company that exceeds the PRB's net tax-interest expense.

It is, however, possible for a CIR disallowance to be allocated to the deemed residual business company that exceeds the net tax-interest expense of the residual business. An actual company that does not have a residual business would be deemed to have a residual business; that residual business would have nil net tax-interest expense. Special rules are therefore required to create additional capacity in the residual business company.

The effect of S452(6) and (7) is to treat the residual business company as bringing in matching amounts of tax-interest expense and tax-interest income in respect of the residual business company. A CT deduction for some or all of the created tax-interest expense may be denied by the CIR disallowance that is allocated to the residual business company. This then results in net tax-interest income that is chargeable to CT as taxable profits of the residual business company from a UK property business. The created tax-interest income is not exempted from CT by the REIT provisions.

The created amounts of tax-interest income and tax-interest expense are equal to each other and must have the same nature as actual tax-interest expense amounts incurred by the actual company in respect of its PRB (S452(9), (10)). This is because, so far as the actual company is concerned, the amounts to be disallowed are tax-interest amounts of the PRB. S452(6) to (10) set out mechanical rules, which permit the CIR disallowance to be allocated to the residual business company for the purposes of the CIR calculations, giving rise to an amount taxable to CT, in place of the requirement to pay an increased PID. This indirectly takes part of the profits of the PRB outside the scope of the REIT exemption. (The classification of amounts of tax-interest into different types is found in S377.)

Preliminary calculations

As an initial step, calculate the aggregate net tax-interest expense and the interest capacity of the group for the period of account. This then determines the total CIR disallowance of the group for the period of account in the normal way.

In calculating these amounts, no special provisions for REITs apply, except that the PRB and residual business of each group company are treated as carried on by separate members of the same CIR worldwide group (referred to as the PRB company and residual business company respectively).

The PRB income and gains are treated as not exempt from CT for the purposes of calculating CIR (S452(4)) see CFM97715.

Step 1

Determine the maximum CIR disallowance that could be allocated to the PRB company and the maximum CIR disallowance that could be allocated to the residual business company following the normal CIR calculation rules. These are the net amounts of tax-interest expense for the respective businesses. The effects of the potential limit on the CIR disallowance that can be allocated to the PRB company in S452(5)(b) is ignored. The sum of these maximum amounts is referred to as 'the total REIT expenses'.

Step 2

Determine the amount (if any) of the CIR disallowance that is actually allocated to the PRB company for the accounting period. This amount is referred to as 'the actual disallowed amount'.

This amount must take account of any limit on the CIR disallowance than can be allocated to the PRB company so as not to require an unlawful distribution to be made – see CFM97730. The effect of this limit is that the maximum amount that can actually be allocated to the PRB company may be less than the maximum disallowance referred to in step 1.

Step 3

Deduct from the total REIT expenses (from step 1) the actual disallowed amount (from step 2).

This gives the amount of the total REIT expenses that remain after taking account of the actual disallowed amount allocated to the PRB company. Note that this comparison is with the total REIT expenses and not the disallowance to be allocated to the company as a whole, which may be less than the total REIT expenses.

Step 4

Determine whether so much of the total REIT expenses as remain after step 3 exceeds the actual net tax-interest expense of the residual business.

This determines if, ignoring step 5, there is insufficient tax-interest expense in the residual business company to absorb any CIR disallowance.

Step 5

Where the application of step 4 produces an excess, it means that, without this step 5, there would be insufficient tax-interest expense in the residual business company to absorb the CIR disallowance.  In this situation, the residual business company is required to bring into account in the accounting period, matching tax-interest expense and tax-interest income amounts equal to the amount of the excess.

This creates additional tax-interest expense within the residual business to absorb the CIR disallowance that is not allocated to the PRB. The actual company thus has tax-interest income that is subject to CT where some or all of the tax-interest expense is disallowed by the allocated CIR disallowance.

Examples

For examples of the application of the rules, see CFM97745 and CFM97746.

Interaction with CTA10/S543

A REIT or the principal member of a group UK REIT may be subject to a charge to CT, under CTA10/S543, to the extent that its property profits are less than 125% of its finance costs (see IFM22205). The income is treated as income of the residual business and not the property rental business.

Absent any special rules, there is a risk that in such cases there is both a charge under CTA10/S543 and a disallowance under the CIR rules. As a result, in cases where a charge arises under S543, the amount charged as residual business income is treated as tax-interest income for the purposes of the CIR rules (S452(4A)). Therefore, there should be a reduction in the CIR disallowance amount that would otherwise arise to the extent of the amount charged under S543.