Following the publication of the summer Finance Bill, we now have confirmation the corporate interest restriction (“CIR”) regime is due to apply from 1 April 2017 whatever a company’s year-end. In this article, we consider the implications for M&A transactions.
Under the corporate interest restriction (CIR) rules, interest-like expenses are disallowed to the extent that the net finance charge taken from the UK tax computations exceeds the interest capacity.
The interest capacity is based on a percentage of tax-EBITDA (taken from the tax computations) or, if lower, a measure of the net interest expense, based on the group accounts (the debt cap), but is always at least £2 million.
The approach to modelling post-acquisition cash flows must now take account of the impact of the CIR rules on the expected tax relief for financing costs as, going forwards, modelling will become much more difficult.
The model must take into account the hybrid and other mismatch rules and the interaction with the revised loss utilisation rules. The combination of rules and restrictions is leading to greater complications and we’re seeing old assumptions being thrown out the window.
The CIR rules operate by reference to the ‘worldwide group’. In particular, the total disallowed amount is computed on a group-wide basis and is then allocated between UK group companies. It is vital to correctly identify the ultimate parent and which entities comprise the worldwide group. Typically this follows the International Accounting Standards (IAS) definition of consolidated subsidiaries.
Generally speaking, a worldwide group will consist of all entities that would form part of a group applying IAS; broadly, a parent and its consolidated subsidiaries. An IAS parent will only be treated as the ultimate parent if it is a ‘relevant entity’, which is defined as a company or an entity whose shares, or other interests, are listed on a recognised stock exchange and are sufficiently widely held (i.e. no participator holds more than 10 percent by value). The CIR grouping rules mean that a partnership is only capable of being the ultimate parent of a worldwide group if it meets the relevant conditions described above.
A subsidiary under IAS will not qualify as a CIR subsidiary if the investment in that company is measured at fair value under IAS (as opposed to having its results consolidated on the more normal line-by-line basis). Such a company is excluded from the CIR group of its IAS parent.
For groups which are owned by private equity partnerships, particular care will be required to identify the ultimate parent.
The CIR rules provide for disallowed interest-like expenses and unused allowances to be carried forward to a later period. If there is a change in ownership of a company or group, an assessment is required as to whether these attributes are still available and who can access them.
- Where a group is acquired, the ‘old’ group ceases and any carried forward interest allowance is lost. Similarly, any carried forward allowance will be lost where a new top holding company is inserted which becomes the ‘new’ ultimate parent of the group, e.g. if a new holding company is added in preparation for an IPO.
- Where a subsidiary is sold or purchased, they will not be able to take with them any interest allowance from when they were a member of the seller group; instead the seller group will retain the ability to utilise any carried forward interest allowance.
It should be noted that whereas a group’s capacity to access relief for current year interest is increased by any unexpired interest allowance carried forward from earlier periods (see above), its capacity to reactivate interest disallowed in prior years only takes account of the current period interest allowance. It is generally unlikely that a group would have both carried forward disallowed interest and a carried forward unused interest allowance but this could arise following an acquisition. For example, where a group with unexpired carried forward interest allowances (and no previous disallowances) acquires a company with carried forward disallowed interest, it will only be possible to reactivate such disallowed interest to the extent that the group has current year excess interest allowance after the acquired company has joined the group. This illustrates the level of detailed understanding of the rules which will be required to model the impact of the acquisition.
For each period, a group can elect to calculate the interest allowance based on the group ratio method. Under this method, the interest capacity is based, in part, on a group accounts measure of net interest-like expenses (known as qualifying net group-interest expense). For these purposes, interest-like expenses payable to a related party are not included, thereby reducing the capacity to deduct interest. If the group ratio method is to be used, it will be necessary to assess whether the group is paying interest etc. to related parties.
For example, bank borrowing can be treated as being from a related party where a guarantee, indemnity or other financial assistance is provided by a related party who is not a member of the group. However, a bank’s security package should not cause them to be treated as a related party in relation to the borrowing, provided the guarantee is only from companies within the group.
Where a group is owned by private equity partnerships, particular care will be required to identify funding from related parties.
The CIR rules contain over fifteen possible elections which can mostly be made or amended after the end of a period. Where companies are purchased and sold, it will be necessary to assess the impact of elections on the acquired company or group.